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Edited Transcript of INGN earnings conference call or presentation 7-Aug-19 12:30pm GMT

Q2 2019 Inogen Inc Earnings Call

GOLETA Sep 5, 2019 (Thomson StreetEvents) -- Edited Transcript of Inogen Inc earnings conference call or presentation Wednesday, August 7, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alison Perry Bauerlein

Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer

* Matthew James Bacso

Inogen, Inc. - IR & Corporate Development Manager

* Scott Wilkinson

Inogen, Inc. - CEO, President & Director

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Conference Call Participants

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* Danielle Joy Antalffy

SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst

* Jonathan Preston McKim

Piper Jaffray Companies, Research Division - VP & Senior Research Analyst

* Malgorzata Maria Kaczor

William Blair & Company L.L.C., Research Division - Research Analyst

* Matthew Ian Mishan

KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst

* Michael Stephen Matson

Needham & Company, LLC, Research Division - Senior Analyst

* Robert Justin Marcus

JP Morgan Chase & Co, Research Division - Analyst

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Presentation

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Operator [1]

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Good morning, everyone, and welcome to the Inogen 2019 Second Quarter Financial Results Conference Call.

(Operator Instructions) Please also note today's event is being recorded. And at this time, I'd like to turn the conference call over to Mr. Matt Bacso, Investor Relations manager. Please go ahead.

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Matthew James Bacso, Inogen, Inc. - IR & Corporate Development Manager [2]

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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 second quarter of 2019. This earning 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, expectations related to sales headcount, hiring expectations and strategy, HME strategy and expectations, rental strategy changes and the timing and impact of such changes, expectations from revenue channels, marketing expectations, the rollout of Inogen One G5, expectations regarding the impact of Chinese tariffs, expectations regarding competitive bidding, our expectations on the benefits in market opportunities of the Tidal Assist Ventilator or TAV, the potential of TAV to disrupt the non-invasive ventilator market and expand to treat COPD patients, our expectations on TAV sales, our expectation to integrate TAV technology into our oxygen concentrators, financial guidance for 2019 including the impact of the expected New Aera acquisition and expectations for 2020.

The forward-looking statements in this call are based on currently available to us. These forward-looking statements are only predictions and involves risks and uncertainties that are set forth in more detail in our most recent periodic reports filed with Securities and Exchange Commission. Actual results may vary, and we disclaim any obligation to update these forward-looking segments except as may be required by law.

We have posted historical financial statements in our second quarter investor presentation in a separate presentation on New Aera acquisition in the Investor Relations section of the company's website. Please refer to these files for more detailed information.

During the call, we'll also present certain financial information on 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 to make operating decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented in tables of -- in the earnings release. For future periods, we're 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?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [3]

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Thanks, Matt. Good morning, and thank you for joining our second quarter 2019 conference call. Looking at the second quarter of 2019, we generated record total revenue of $101.1 million, which is the first time we have surpassed the $100 million threshold for a quarter and reflects growth of 3.9% over the second quarter of 2018. Direct-to-consumer sales of $43.6 million in the second quarter of 2019 increased 14% over the second quarter of 2018, primarily due to increased sales representative productivity, partially offset by an approximate 17% reduction in sales representative headcount in the comparative period of the prior year. The level of sales representative attrition was higher than expected in the second quarter as many of the reps that we hired in 2018 were unable to meet our sales targets. Furthermore, while sales represented productivity improvements more than offset the loss in sales headcount in the quarter, it did not meet our expectations. Despite successful early trials, where we allocated more leads to top-performing representatives when scaled across the larger group, this initiative did not generate the benefit we anticipated. Given the reduced sales representative headcount and less than expected productivity improvements, we expect to realize headwinds to grow in direct-to-consumer sales in the third and fourth quarter of 2019.

With realized improved productivity, we have restarted our sales capacity expansion efforts with the new sales representatives hired across all 3 facilities in August 2019. Going forward, we plan to hire at a more controlled pace than what we did in 2018, and we believe we are making the necessary changes to improve our sales management infrastructure to support sales training and onboarding. We've also made key changes to management personnel to drive better productivity, lower attrition, and improve sales predictability. However, we expect sales representative headcount to be down significantly at year-end 2019 compared to year-end 2018, which is the largest driver of our reduced 2019 revenue expectations.

Given the number of leads we were able to consistently generate on a monthly basis, we believe the market remains under-penetrated, but we need to execute our sales capacity expansion and productivity plans to drive future direct-to-consumer revenue growth. Second quarter of 2019 rental revenue of $5.2 million decreased 1% compared to the second quarter of 2018, primarily due to a 9.1% decrease of patients on service, partially offset by higher rental revenue per patient. We had approximately 25,900 patients on service as of the end of the second quarter of 2019.

In the second quarter of 2019, we made a modest change to our rental intake criteria and initiated our plans to sale a separate rental team. But we did not expect a meaningful contribution from this team until early 2020. Due to the reduction in sales headcount, we now expect rental revenue to be down modestly in 2019 in spite of changes intended to increase rental revenue, such as the change to the rental intake criteria and establishing a separate rental team. We expect patients on service to increase in the back half of 2019 from the second quarter of 2019, and we expect both patients on service and rental revenue to increase in 2020. Second quarter 2019 domestic business-to-business sales of $29.7 million decreased 10% from the second quarter of 2018, primarily due to a decline in sales to a large national provider who purchased through our private label partner, and secondarily due to a decline in sales to our Internet reseller partners. The large national provider that we have discussed in our last earnings call accounted for revenue of $700,000 in the second quarter of 2019, down from $8.3 million in the second quarter of 2018.

Sales to our internet reseller partners were down in the second quarter of 2019 versus the second quarter of 2018, as our reseller partners did not see the typical seasonal increase in orders as seen in previous spring and summer months. Excluding this one national provider and sales to our Internet reseller partners, we continued to see strong demand from traditional HME customers. While HME providers continued to convert and purchase portable oxygen concentrators, we continue to expect that growth will be challenged due to ongoing restructuring efforts, lack of access to available credit and provide our capital expenditure constraints.

As we have discussed in the past, HME providers have communicated to us that they continue to be subject to capital constraints and certain providers have indicated that they intend to reduce or limit purchases in the future. Additionally, we believe providers will be more conservative with capital investments in the next year due to pending competitive bidding around 2021 and the lack of visibility to who will win contracts and changes in reimbursement rates. Even though we still believe the market is underpenetrated, patient demand is strong and we have a market-leading product offering. Given these challenges and uncertainties for our business-to-business customers, we are lowering our growth expectations for HME providers and Internet resellers for the remainder of 2019.

Second quarter 2019 international business-to-business sales were solid at $22.6 million, representing reported growth of 8.7% and 14.7% on a constant currency basis. Underlying European demand trends remain strong as we remain the preferred provider of POCs for key European accounts.

Transitioning to the Inogen One G5. We launched in the direct-to-consumer channel in April 2019, and we believe we strengthened our technology leadership position with this product. As a reminder, this product is the smallest, lightest and quietest portable oxygen concentrator in the market today that produces greater than 1,000 milliliters per minute of oxygen. As communicated on our first quarter call, we expect to roll out the Inogen One G5 to domestic business-to-business channel in the third quarter of 2019, and then to the international business-to-business channel by the end of 2019, pending standard regulatory clearances in each market.

On the topic of competitive bidding around 2021, as expected, the bidding windows open July 16, 2019. Bids are due by September 18, 2019. We still plan to bid in 129 of 130 regions but we cannot discuss our bidding strategy publicly. We expect pricing to be announced in the summer of 2020 and contract winners to be announced in the fall of 2020 before contracts go into effect January 1, 2021. As part of the competitive bidding around 2021 bid preparation tools, CMS provided 2017 and 2018 traditional fee-for-service Medicare beneficiary accounts for each competitive bidding area by each HCPC code. In evaluating this data, we can now see that penetration rates for POCs are higher in CBAs versus non-CBAs areas.

In 2017, while the total traditional Medicare penetration rate for POCs in the total U.S. oxygen market was 10.8%, it was 14% in CBAs. While we won't know the total 2018 penetration rate until the data is published in October 2019, we can see that the traditional fee-for-service Medicare beneficiary penetration rate for POCs in the total U.S. long-term oxygen therapy market in CBAs was 18.8% compared to 14% in 2017. POC adoption is continuing to progress, but we believe we are still a long way from our estimated full market penetration of 65%.

Now I'd like to spend some time discussing the significant announcement today of the signing of the definitive agreement to acquire New Aera, an innovative developer and manufacturer of portable non-invasive ventilators for people suffering from various chronic lung diseases. We are very excited to announce our plan to acquire New Aera and certain assets from a related entity for a cash payment of $70.4 million at closing with potential earn-out payments of up to $31.4 million based on future sales performance, and certain regulatory clearances.

We believe New Aera is an innovator in ventilator nasal interfaces and a natural fit with our current business as it strengthens our position in our core oxygen therapy market, which aligns with our mission to increase freedom and independence for oxygen therapy patients through innovative products and services. We plan to incorporate the Tidal Assist Ventilator or TAV technology directly into our Inogen One portable oxygen concentrators and make the side kit TAV product compatible with our Inogen at-home stationary concentrator to continue to advance patient preference and maintain our technology leadership position in the long-term oxygen therapy market.

New Aera completed a small peer-reviewed clinical trial comparing the use of their SideKick TAV product with oxygen to standard oxygen alone for patients with either moderate to very severe COPD or interstitial lung disease. The trial showed these patients were able to exercise longer with markedly better oxygenation and less dyspnea and leg fatigue on TAV therapy than on oxygen therapy alone. The trial indicated that 83% of patients responded positively to TAV versus 11% on oxygen alone and showed a 136% mean endurance increase. We believe this will allow us to strengthen our product portfolio in oxygen therapy and allow an additional retail sales opportunity.

In addition, we plan to use this technology as a platform to expand our total addressable market into the high-growth non-invasive ventilation or NIV market. We estimate NIV to be an addressable U.S. market opportunity of over $400 million in 2019, based on the estimated claims paid for traditional fee-for-service Medicare beneficiaries and has grounded over 20% per year since 2016.

We believe there is a significant worldwide untreated market opportunity. We also believe the NIV market could undergo disruption, similar to oxygen, given the pending reimbursement changes due to the inclusion of this category in competitive bidding around 2021, and the immobile nature of legacy NIV product offerings. The monthly Medicare reimbursement rate is significantly higher for NIV products than oxygen therapy at a minimum of $934 a month. Also effective January 1, 2019, a new Medicare HCPC code has been added to allow billing for a multifunction ventilator that includes ventilation and oxygen. We are targeting to launch a product for this purpose in 2021.

Furthermore, we believe that this technology can be used to help a portion of the over 200 million COPD patients worldwide who are currently not on oxygen therapy and are willing to pay out-of-pocket to reduce breathlessness particularly, during exercise. This technology represents an attractive new opportunity for us in an adjacent market that would leverage our existing direct-to-consumer expertise. We plan to sell the existing SideKick TAV product to consumers through our inside direct-to-consumer sales force, and our physician sales force and also to business-to-business customers worldwide.

The SideKick TAV is a prescription required non-invasive ventilator designed for select patients with various chronic lung diseases. SideKick TAV's unique design is approximately 4 ounces and is compatible with certain oxygen concentrators, oxygen cylinders and wall gas providing 1 to 5 liters per minute of oxygen and can deliver higher flow and pressure versus traditional oxygen therapy. We expect sales of the SideKick TAV product to begin in 2020, and we believe it will be gross margin accretive versus our existing oxygen therapy business.

Looking in 2019, we are reducing full year 2019 total revenue guidance to $370 million to $375 million, down from $405 million to $415 million, representing growth of 3.3% to 4.7% versus 2018 full year results, primarily associated with reduced expectations of our direct-to-consumer sales channel. We expect revenue in the third quarter of 2019 to be down compared to the third quarter of 2018, due to headwinds in both the domestic business-to-business and domestic direct-to-consumer channels. In spite of the expected increase in productivity of our sales representatives, direct-to-consumer sales will be negatively impacted by a reduction in sales headcount compared to the same period in the prior year.

Given the difficult growth comparisons we face in the domestic business-to-business sales channel, the restructuring challenges of some providers and the decrease in Internet reseller purchases, we expect declines in the domestic business-to-business channel in the third quarter of 2019 compared to the third quarter of 2018. We expect international business-to-business sales to have a modest growth rate for the remainder of 2019 compared to 2018, in spite of currency headwinds with easier comparables in the fourth quarter of 2019, due to lower growth rates seen in the fourth quarter of 2018.

We now expect rental revenue to be down modestly in 2019, in spite of the slight change to intake criteria due to reductions in sales headcount. But we do expect the number of patients on service to begin increasing in the back half of 2019 from the second quarter of 2019.

Lastly, the New Aera transaction is not expected to materially contribute to Inogen's 2019 revenue, but we do expect contributions in 2020. While we are not providing 2020 guidance today, we believe we can execute on our plan to return to double-digit revenue growth in 2020. With that, I will now turn the call over to our CFO, Ali Bauerlein?

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [4]

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Thanks, Scott, and good morning, everyone. During my prepared remarks, I will review our second quarter of 2019 financial performance and then provide more details on our updated 2019 guidance. As Scott noted, total revenue for the second quarter of 2019 was $101.1 million, representing 3.9% growth over the second quarter of 2018.

Turning to gross margin. So the second quarter of 2019, total gross margin was 49.7% compared to 49.8% in the second quarter of 2018.

Our sales gross margin was 50.7% in the second quarter of 2019 versus 51.1% in the second quarter of 2018. The sales gross margin decrease was primarily due to lower average selling prices, partially offset by increased sales mix towards higher margins domestic direct-to-consumer sales and lower cost per unit in spite of the Inogen One G5 launch and increased tariffs. Rental gross margin was 30.4% in the second quarter of 2019 versus 27.6% in the second quarter of 2018. The increase in rental gross margin was primarily due to increased rental revenue per patient on service and lower depreciation expense, partially offset by higher service cost. As for operating expense, total operating expense increased to $38.1 million in the second quarter of 2019 or 37.7% of revenue versus $34.4 million or 35.4% of revenue in the second quarter of 2018.

Research and development expense decreased to $1.5 million in the second quarter of 2019 compared to $1.8 million recorded in the second quarter of 2018, primarily due to decreased personnel-related expenses.

Sales and marketing expense increased to $27.8 million in the second quarter of 2019 versus $23 million in the comparative period of 2018, primarily due to increased advertising expenditures, partially offset by decreased personnel-related expenses. In the second quarter of 2019, we spent $11.6 million in advertising as compared to $6.3 million in Q2 2018.

General and administrative expense decreased to $8.8 million in the second quarter of 2019 versus $9.7 million in the second quarter of 2018 primarily due to decreased personnel-related expenses, partially offset by $0.3 million in costs associated with the New Aera transaction.

Operating income for the second quarter of 2019 was $12.1 million, which represented 12% return on revenue, compared to operating income of $14 million or 14.4% return on revenue in the second quarter of 2018. The reduction in second quarter 2019 operating margin compared to second quarter of 2018 was primarily due to increased marketing expense.

In the second quarter of 2019, we reported net income of $10.2 million compared to net income of $14.6 million in the second quarter of 2018. Earnings per diluted common share was $0.45 in the second quarter of 2019 versus $0.65 in the second quarter of 2018.

Now turning to guidance. As Scott mentioned, we are reducing full year 2019 total revenue guidance to $370 million to $375 million, down from $405 million to $415 million, representing growth of a 3.3% to 4.7% versus 2018 full year results, primarily associated with the reduction in expected direct-to-consumer sales.

We expect a $5.2 million in incremental cost associated with the New Aera transaction in 2019, with approximately $2.9 million in intangible amortization expense, $1.5 million in other operating expense and acquisition expenses of approximately $0.8 million, including $0.3 million of expense incurred in the second quarter of 2019. We're reducing full year 2019 net income guidance to a range of $23 million to $25 million compared to our previous net income guidance of $36 million to $38 million. This decrease in net income guidance range is primarily due to the estimated reduction in revenue and increased expenses associated with the New Aera transaction but partially offset by an estimated reduction in other operating expenses. We expect the GAAP effective tax rate of approximately 25% in 2019.

The guidance assumes that tariffs associated with imported Chinese materials and products stay at a rate of 25% for the remainder of 2019. On August 1, 2019, President Trump announced new 10% tariff on up to $300 billion in additional goods imported from China effective September 1, 2019. We are still evaluating the impact of these tariffs on our financial results.

Going forward, we plan to continue to monitor any new tariff proposals and economic policy changes and take the necessary step to protect financial interest and reduce our standard material cost of risk. We're also reducing full year 2019 operating income guidance range to $26 million to $28 million, inclusive of the New Aera incremental cost compared to previous operating income range of $42 million to $44 million. And we are also reducing our full year 2019 adjusted EBITDA guidance range to $49 million to $51 million, inclusive of the New Aera incremental nonamortization cost, down from $66 million to $68 million. With that, Scott and I can take your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question today comes from Danielle Antalffy from SVB Leerink.

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [2]

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Scott and Ali, I just wanted to start with a, sort of, a higher-level question. I guess what gives you -- it feels like initially, this was an issue in the B2B domestic side things with the major HME providers slowing purchasing, now it feels like you're getting ahead a little bit on all sides. And I guess what -- the first question is, what gives you the confidence that it's not something deeper, more underlying market dynamics? I get that POC concentration or penetration, sorry, is increasing, but you do have another competitor out there? Is it increasing to the extent that we thought? Is there something that has to do with the pricing dynamic? And you can give us a little bit of color about what gives you confidence that the underlying growth is still there? Number 1, number 2, that Inogen is still in a winning position because I do know that you guys priced it at a premium to the competition. So just a little color on your confidence behind the underlying growth here?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [3]

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Yet, thanks, Danielle, I'll take that one. So let's kind of peel back the onion on a couple of different areas for a second. First, I'll start with direct-to-consumer sales and the market and where we are in the market. So if you look at all the numbers that Medicare provides whether it's through the recent competitive bidding tools or the penetration rates that we use traditionally tracking the HCPC codes, the market is still way below the full-penetration point. We have confidence in that, that -- and we also validate that, that when we look at a number of leads that we can generate every month, it's tens of thousands of leads of real oxygen patients that answer our advertising that they're trying to get a POC. So I think, when we assess is the market saturated or fully penetrated, those numbers indicate that we still have opportunity not only now about into the future. And that's why we're getting back on the horse to expand our sales capacity, again, so that we can drive growth in the future.

Now if you will also peel back the onion on the issues with the B2C sales, we've talked about in the last call or so that some of the reps that we hired in 2018, we struggle to get them up to curve, and we continued to work with them to a point wherein the second quarter, a lot of them worked themselves one way or another out of the company. Some of them left of their own accord because they didn't -- they weren't successful, they didn't make the money they expected because they didn't hit their quotas. And some after trying to work with them, it was clear that they just couldn't do this job successfully, so we proactively transitioned them out. When you compare that with our other sales reps and seasoned sales reps and you track their productivity and success, we still see great results with them. So if you had market saturation issues, you'd see a decline in some of those other metrics with the seasoned reps. So when we peel that back and look at well, what can we do better, where did we have execution challenges and how are we going to address those? We've put real plans in place as far as improving our hiring intake criteria, looking at better metrics to make sure that we consistently follow processes through the hiring and onboarding process, we've put more infrastructure in place to support those reps as they come up the curve. And we've also, while it's been a small amount, we have had 2 hiring classes with some of these changes implemented. And we've seen great results with those small classes.

So 2 smaller classes, those folks have beaten the historical productivity curves. We have had almost no attrition from those classes, and they're having success. So when you roll all that up, we have confidence to begin hiring again and expand our sales capacity, but you kind of have to bite off some of the attrition that we had to swallow. Because obviously, we didn't execute as well as we have historically and that is going to take a toll on our ability to grow the rest of this year, but long term, we think we're still in a great position for growth. We still are the market leader. We still have the best product, patient-preferred products. And we talked a little bit in my prepared remarks about the G5 launch, not only have we traditionally had the best product, but we just launched an even better product than what's the best. So we feel very good about the future and our ability to get back on that double-digit growth wagon.

Now that's on the B2C side. Now if we talk about B2B, the struggles that we've just described here and the challenges really aren't any different than what we've talked about in the past. Providers have always been undercapitalized, they've always been challenged with cash flow. We've developed some innovative financing programs to help them, but they still have to swallow the restructure hurdle to really make the nondelivery model work. So we acknowledge that's going to continue to be a challenge. I think competitive bidding, kind of, hit them between the eyes and being right in the middle of a bidding window has a little bit of a psychological effect on everyone, makes them a little more pessimistic. And then for the smaller players, it's a very real challenge because there's a chance they could get screened out of the market. So we expect they'll be a little bit more conservative going forward until it shakes out, are they in or they out and what the rates are going to be? And these are headwinds that we've dealt with on and off through the past. They're just not going to go away. It's why we've said despite POCs being compelling from a cost-to-service standpoint as well as patient-preference standpoint, that this transition is a process, not an event because of those hurdles.

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [4]

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(inaudible) on there, Danielle, I know you also asked about pricing and competition. We really aren't seeing anything dramatically different in the market in those areas. Pricing, well, our business-to-business customers are always price-sensitive, we aren't seeing any new dynamics from a competitive front. So we believe we're continuing to mention our market leadership position there, and that those are not the dynamics impacting our changes and assumptions going forward.

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [5]

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Got it. Okay, that's helpful. And then, I know you're not giving 2020 guidance, but Scott you mentioned you thought a double-digit growth return would be doable to double-digit growth. I guess could I ask, could these issues that you guys -- headwinds that you're facing seem like it's hard to predict? How quickly they'll lift? And for example, when the major HME provider will start purchasing again? And so I guess, what are you looking out there that gives you the confidence? Are you having conversations with the large HME provider that makes you think they'll start purchasing again in 2020? Can you give a little bit more color to the drivers of that comment there?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [6]

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Yes. The large national that we talked about in the past, we don't have them in our growth plans or returning to purchase. So if they were to do that, that would be upside. We continue to think that their struggles are more longer term to address their restructuring hurdles. The other home-care companies out there, they faced some of those similar hurdles, they just haven't decided to stop purchases. They're up-and-down and you see, one is up and other is down any given quarter. We don't expect and we are in pretty close contact with people, I'll say, we try to be in closer contract, given what happened with that large national. Nobody is telling us that they don't see POCs as the future but they do convey their hurdles. So you have to balance that that, they're trying to convert their business, they're trying to serve patient demand but they have some constraints. So we'll help them to the extent that we can but what really is important to us and I think, again, what's unique for us with our direct-to-consumer approach is that we can drive more of our own destiny. And well, to some extent, we're little dependent on them. I mean they're pretty sizable portion of our revenue portfolio, they're not our entire revenue portfolio. So for us to continue to drive that sales capacity growth when we model that out and kind of lap where we are being down in headcount now and projecting where that would be next year, that gives us the confidence to make a statement that we feel we can return to double-digit growth in 2020.

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [7]

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Yes. Just to expand a bit that Danielle, when we look at our total revenue excluding that national account on a year-to-date basis, we're up 19.6%. So obviously, we are dealing with comp issue that gets -- that eases a bit in the back half of this year and is really -- we're through that headwind going into 2020. So that's just in and of itself should help the overall growth rate lapping those large sales that we saw in 2018, and with the additional hiring and what we're seeing on the B2C side, we also should be lapping the tougher comps there and that should help 2020 as well. We also expect as we said, rental revenue to start increasing and not being a headwind to growth going into 2020 as well.

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Operator [8]

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Our next question comes from Malgorzata Kaczor from William Blair.

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Malgorzata Maria Kaczor, William Blair & Company L.L.C., Research Division - Research Analyst [9]

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Yes. Can you guys hear me?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [10]

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Yes.

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Malgorzata Maria Kaczor, William Blair & Company L.L.C., Research Division - Research Analyst [11]

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Perfect. Sorry about that. Good morning and thanks for taking my questions. First off, I was hoping to maybe drive a little bit more Danielle's second question, which kind of talked to that double-digit growth rate that you guys have had referenced for 2020. So I understand that the underlying business right now is growing 19%, there's still a few moving pieces obviously, between the sales reps returning back to productivity, and what you referenced was just kind of continued attrition maybe 3-year add relative to where you guys finished 2018 with. So maybe, you can talk through kind of the cadence of that as we move forward beyond just this year? And then are you guys looking at new products or new geographies as major drivers, as you go into 2020 and beyond?

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [12]

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Yes, sure. So from the side of looking at this double-digit expected growth going into 2020, we aren't assuming any material contribution from new countries. So our focus still will be in the U.S. and Europe as our primary market. Obviously, we do plan to continue to look for opportunities outside of there, but that really isn't contemplated in the numbers that we discussed here, and that doesn't include any contribution in new areas like China. From new products, we are assuming a small, relatively small contribution associated with the New Aera product portfolio, which we are very excited to add to our product portfolio, although there is some additional R&D work there to get full use of the technology over the next couple of years, but we are assuming that, that does start to contribute in 2020. So on top of that, just in terms of cadence, obviously, we're not giving specific 2020 guidance today. It is very early for us to even comment on 2020. So we would expect the underlying seasonality trends to be similar to what we've seen in prior years with, I know, higher sales in the second and third quarter versus the fourth and first quarter. But outside of that, we need to get a little closer to the year before we comment on specific seasonal trend.

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Malgorzata Maria Kaczor, William Blair & Company L.L.C., Research Division - Research Analyst [13]

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Okay. And then in terms of the New Aera acquisition that you guys had referenced, and there's a few products I think in that category that have been out there. So as you look at evaluating them, marking which asset was the right asset to target? Why then? Is it something that's easier to incorporate into your device on your POC? That gives you that competitive advantage in the space? And then if you could give us a sense of the commercial model if you're going to sell a DTC in the near term. Do you guys have a sense of ASP or gross margin contributions for that? And then just slightly going more in there, how do you expect traditional NIV players to respond to kind of you guys entering market with kind of your unique combination?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [14]

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Yes. I mean we think that the New Aera product and technology fits perfectly with not only our oxygen product portfolio that we have today, but also it's very complementary with our go-to-market strategy. The great thing about this product is that we liked about it, it is not only the efficacy is proven in the clinical study, peer-reviewed study that they ran but also, it's designed for patient preference and simplicity and ease-of-use, which is kind of our success formula for our POCs. So it's a product that we think that we can leverage our sales force as well as our marketing spend because many of the current leads that we generate right now would be candidates for the New Aera product. So we can get some leverage there, it's an area where we have expertise in respiratory and oxygen therapy services. So for our first acquisition, it fits close to home. It also allows us to get into adjacent markets, downstream in the noninvasive ventilation for really the sicker patients that need ventilation in addition to oxygen therapy but also upstream, where we think that we can impact a portion of some of the basic COPD patients that have breathlessness, where really there isn't any coverage criteria or anything that they fit under, but it's a retail opportunity for us. And we have a great retail model that we have proven over the last 10 years. So again, we think that fits nicely with our core competency and where we are unique.

As far as the channels we would sell it in, obviously, I just mentioned direct-to-consumer, we think it fits nicely there. It'll also be a perfect fit for our physician sales force, something that they can showcase in front of doctors. And we think that it could play a big role to get the product jump-started and get some exposure in pulmonary rehab facilities. We've already seen that in the very limited sales that New Aera has actually had. They got their FDA clearance last year and just started to sell a small amount of products, and then got to a point where it made sense to take this to the commercial stage that they would hand that off to somebody that had more horsepower rather than develop that themselves.

Lastly, we'll sell this to the business-to-business community just like we do POCs. We want to use that community to broaden access to this product concept of patients just like we do POCs. It's, as I said, patient preferred but it's also relatively low cost. We think that cost in NIV is going to be more important as you look forward if indeed it remains included in the competitive bidding program. And again, we think that products that have kind of gone through that program where there's downward reimbursement pressure, there is opportunity for disruption. As far as what other people are going to think, that's probably -- I'd rather they answer what they're going to think. But I think that we've shown we're a strong competitor in POCs as a market leader, we've got a unique go-to-market strategy. We're going to leverage all of that horsepower to take full advantage of that TAV product and technology.

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Operator [15]

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Our next question comes from JP McKim from Piper Jaffray.

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Jonathan Preston McKim, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [16]

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Can you just help me get to -- just kind of downed Q3 guidance, I'm just playing around with the model. And I -- it's hard for me to get there? Is international the only segment that's going to grow?

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [17]

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So we don't give specific guidance there, but we did say on the call that we expect both domestic B2B and B2C to be down year-over-year. Rental will also have a headwind that just associated with the strong Q3 and a change in both the rates that were effective January 1 and the change in bad debt accounting that was effective January 1. So those will all be headwinds to growth for us in Q3.

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Jonathan Preston McKim, Piper Jaffray Companies, Research Division - VP & Senior Research Analyst [18]

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Okay. And then I kind of just have one -- ask one I think, like, on the DTC side. Like I -- I guess there's more attrition and maybe the productivity ramp as -- didn't quickly ramp as you thought. The fact that Internet resellers are down as well makes me think like they're seeing similar issues and like their business model probably hasn't changed in terms of selling on the direct channel as well? So maybe if you could just, if it's -- if you can talk about lead growth, whether that's still growing? Or anything that can give us a little more confidence that it's -- that the leads are there, given that reseller and you guys are seeing the same sort of problem on closing business?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [19]

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Yes. On the Internet resellers side, as I mentioned in my comments, that they didn't see the seasonality benefit that we traditionally see. Now you have to remember the Internet resellers are -- they're not investing for growth, they're typically, privately owned companies that focus generally more on bottom line than growth. That's their model. We can comment on what we've seen because we don't have visibility exactly to what their leads are. We obviously, see their sales patterns and talk to them about their struggles and things, and they didn't see that uptick. It was kind of a -- if you look at it from a pure weather standpoint in the spring, it was a crummy spring with colder than it usually is. And we usually see that uptick coincide with when the weather warms up. This was a little stranger weather pattern we've seen in the past.

We saw consistently across all of them that they had a similar pattern that they didn't bump up. Now their purchases now are pretty consistent meeting our expectations of what we would expect right now. If we look at our own metrics that we've got, which is, obviously, we have a lot more visibility of our own than theirs. I go back to the inherent productivity gains that we were able to drive with our seasoned reps. Our issues tended to be more with the reps that we are trying to bring up the curve and as I said, there's unfortunately, higher percentage of those reps that were not successful than we anticipated. That is a disappointment, but it's one that we have to deal with, and we have kind of dealt with that through the second quarter.

Again, generating many thousands, tens of thousands of leads every month gives us the confidence that there is many, many patients out there, many more patients dragging around a tank that would like to be carrying a POC. And it's our job to execute the sales and growth plan so that we can harvest that opportunity. That's what we'll do going forward. But obviously, if we thought that we were hitting a saturation points, we wouldn't be back to hiring more reps and expanding our capacity there. All the numbers that we have say that we still have room to grow in oxygen therapy and we're going to continue to use that sales capacity to drive that growth.

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [20]

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And just to add a little bit onto that point on their Internet resellers. First of all, I do want to say that for the Internet resellers as a sub-section of the channel of domestic B2B, Q2 was their toughest comp year-over-year. Q2 last year was a very strong number for them as we also saw in our business as well. So I want to point out that, that was a very tough comp. I also want to point out that the resellers, as a percent of our domestic B2B channel, are less than 1/3 of the total. So this is a smaller section versus the traditional HME purchases that is the majority, vast majority of the U.S. B2B segment.

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Operator [21]

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Our next question comes from Robbie Marcus from JPMorgan.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [22]

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I was hoping you could just touch on your view, you said that you're still getting high-quality leads, the reps just aren't able to act on them. What gives you confidence that they are high-quality leads? So what is it that's causing reps not to be able to act on them like they would have, let's say, a year ago? And what gives you the confidence that the new reps that you'll be hiring going forward will be able to act on them differently than the ones hired in 2018?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [23]

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Yes. It's a good question, Robbie. So again, we kind of measure things year-over-year to make sure it's apples-to-apples looking at what we call on our seasoned reps. And if you look at the productivity and close rates in the success of our seasoned reps, they're actually improving. And that's part of the productivity gains that we showed in the second quarter. That's really across the seasoned reps as well as some of the newer reps that we were able to improve their performance and they remained with the company. Our real issue has been with a lot of the newer reps that we hired in 2018 where we frankly just, in some cases, probably didn't hire the right people. We've tried and redoubled our efforts to retrain them and make them successful, but it just comes down to, some of them were not successful, and they have transitioned out of the company, either of their own accord or they didn't meet our performance expectations, and we eventually took some steps to make changes. But when you measure it against our -- the same reps that were here year-over-year were actually showing good productivity improvement.

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [24]

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Yes. And just to elaborate on that a bit. When we look at the leads, they are randomly distributed to the reps. So it's not like reps have specific territories and the older reps would have maybe better-performing lead quality sources. The reps for -- each individual rep will work leads from a variety of sources and from a variety of portions of the country. So because of that random nature, you can really look at how the seasoned rep pool is performing for indications of lead quality that you may not see in a specific rep class. So that, I think, is an important thing to understand when looking at performance and lead quality.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [25]

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Okay. Just a follow up on that. So what will change going forward? And I guess maybe, what is it about the reps that are seasoned and performing well that's different than the reps that you hired last year? And what are you going to change going forward? I guess what gives you the confidence that things will change and the new reps will be more productive?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [26]

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Yes. So we've changed our hiring criteria, our screening mechanisms to make sure that the people we bring in are going to be as good a match as possible, that have a high probability of success. Of course, it's never a guarantee that 100% of everybody you hire is going to work out. But certainly, we had a higher percentage that didn't work out than we had in the past. So that's hurt us. And we've changed that in-take criteria, we've changed our training program, we've changed our support structure and amount of support that we give people. And your question is a good one, well what gives you confidence? I go back to the -- we have hired a couple of classes and measuring those classes that we've hired against the areas where we had issues, we're are seeing success in those classes already. Going forward, again, we're also going to hire in all 3 of our locations. So another key thing that we have kind of found is that those larger classes that we hired in the one single site, people don't get as much one-on-one time through training and onboarding, so we're going to hire smaller classes. We'll give them that more one-on-one time, make sure that we've got enough management infrastructure to support them coming up the curve. And again, that follows our success formula that we've had in the past.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [27]

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And if I could just sneak one more in here. Ali, we've seen operating margins decline in 2019, what gets it back to positive improvements? And is 2020 going to be another investment year, or is that when we can start to see it tick back up?

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [28]

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Yes. I do expect us being able to show some improvement from the 2019 numbers. I do want to remind you that a portion of that change in guidance is associated with the cost for the New Aera transaction that wasn't in previous guidance. Really, what we need to do is execute on our B2C plan to improve their overall sales and marketing efficiencies. That is what's needed in order for us to show improving operating margin. We have been showing great leverage on R&D and G&A but sales and marketing is really the focus area to improve that, particularly going into 2020.

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Operator [29]

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Our next question comes from Mike Matson from Needham & Company.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [30]

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I guess I just wanted to start with the DTC sales force. So I guess -- I know there's been turnover, but I would imagine your numbers are probably still up significantly year-over-year. So let me know, number one, if that's right? And then two, why not try to fix the issues with the reps that are still there, that haven't turned over or left before you go out and start adding more reps? Because I'd imagine you could still get some increased productivity, which would drive growth. It just seems like you're, maybe, putting the cart before the horse here by going -- already going out and trying to add more reps before you fix the problems that you have here.

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [31]

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Yes. So I'll take the first question, and then I'll let Scott jump into the strategy side. So the sales representative headcount that we saw in Q2 of 2019 on average was down about 17% compared to Q2 of 2018. So that was a significant headwind for us, it was the loss of capacity on a year-over-year basis, and obviously, we're able to offset that with improved productivity of both on a smaller side, the actual improvement of the seasoned reps, and then the nonseasoned coming up the curve as we have fewer people in the early stages of that productivity curve. But headcount was down significantly from a sales representative headcount side on a year-over-year basis in Q2, and as part of the challenge going into Q3 and Q4, particularly since we hired significantly in Q3 of last year, that headwind to D2C sales growth will get bigger in Q3 because of that reduction in headcount on a year-over-year basis.

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [32]

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Yes. And in the second part to your question, Mike, of why wouldn't we focus on the reps that are struggling as opposed to going back and hiring reps before you fix the issues. That's actually the process that we've worked through. We have been working with the reps that were struggling, really, for the first of this year and working with them that's where we -- peeling back the onion, again, uncovered some deficiencies through our training process, our support process, those are things that you can fix and, let's say, apply to the reps that are already in place. But there's also, frankly, issues with our screening process, and we concluded and some reps also concluded themselves that they just weren't cut out for this job. And that's where the attrition come in. So we've been trying very hard and thought that we would be more successful than it turns out that we were to make those reps more successful. So we've corrected those fundamental issues, as I said, applied all of those changes to a couple of hiring classes. We are seeing success on those classes, and that's why we're resuming hiring. We've actually started this weekend and we have new classes in this week in 3 of our locations.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [33]

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Okay. I guess I'm just struggling with the math here because my understanding was that you added about 70% to your rep count in the second half last year, and now you are saying that we're not even lapping that yet and you're saying you're down 17% from where you were in the first half. So that implies almost like a 100% reduction in your -- not, sorry, like a 50% reduction in your reps or something?

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [34]

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Yes. No. So the 70% increase that we saw was throughout all of 2018 in our rep base. So we went from 263 sales reps at the end of 2017 to 446 at the end of 2018. Again, those are net numbers after attrition. So that Increase of 70% was throughout 2018. When we look at our hiring round, we did hire throughout the year in 2018, so those increases were significant in those periods. Obviously, we did see a bump up in Q3 in our headcount trend, but there was significant hiring in the first half of 2018 as well.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [35]

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Okay. But the reps you added in the second half of last year are essentially completely gone and then more, right? Because you're already down in the first half from where you were last year?

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [36]

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It's the number, we -- so we do have standard attrition in the business as well. So this is an inside call center that, already, you are having to deal with that attrition level to get back to your base business. So that's built into the numbers as well.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [37]

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All right. And then just -- your stock is down considerably, you do have a fair bit of cash on the balance sheet. I understand you want to do M&A and you've done a deal now, but would you consider buying back stock given the steep decline here that we've seen?

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [38]

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Yes. We've had that discussion in the past, and we think that the best use of capital for us is to continue to look at growth opportunities and drive growth. New Aera, as we mentioned, is the first acquisition. Obviously, in the short term we're going to focus on integrating that business and harvesting that opportunity. But no, that's really not our plan right now is to go do buyback. It's to continue to look for those unique disruptive opportunities where we can leverage our go-to-market approach of patients first and direct-to-consumers and leverage that expertise of direct-to-consumer marketing and drive growth in the future.

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Michael Stephen Matson, Needham & Company, LLC, Research Division - Senior Analyst [39]

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Okay. And then just finally, can you update us on the rental strategy? I mean you made some comments about it. But I guess how big of a part of your business do you want that to become, and how much are you really going to try to promote that part of the business? I mean is that something that could be 20%, 25% of your revenue at some point? I know it would take some time to get there, but...

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [40]

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Yes. So I'll take that one. So as we said on our first quarter call, we did make a small change, a slight change to our intake criteria. It wasn't meant to be as a large shift in our total strategy. So that combined with our focus on having a separate rental intake team, that was just focused on patients who are interested in coming on rental services and separate that out from the sales team, we think that, that will drive increased rentals over time. Now it takes some time to build up that rental intake team. We have continued to build out that team, but we expect that to take through the end of this year for us to build out that rental intake team. So that's why we expect, really, going into 2020 is when you start -- we'll start to see rental contributing at a higher level. However, our focus still is on direct-to-consumer sales as that is a higher margin business for us. So that will be the primary focus. So while we do expect rental revenue to increase, grow into 20% to 25% revenues is not realistic in the near or medium term.

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [41]

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Yes. Let me add to that. Mike, so what rental does for us is, it gives us broader access to the market, okay. And to the extent that we need to use that really depends on the traditional HME community. If they are able to continue to grow, make our product readily available to patients. It's probably obvious that more patients are going to want to access the product using a rental or a Medicare insurance benefits than can pay cash. If they can help us there, then we probably don't push rental quite as hard; but if they can't, it's a way to make sure that patients aren't blocked from the market to access our product. And so there's kind of a -- its strategy to make sure that we have access, that patients have access. The other thing that it does is, it lets us better utilize the leads that we generate. And we've talked about that in the past that we want to drive more efficiency and lead utilization. So to the extent that we take on more rentals, we're able to utilize more of those leads that we pay for. But that's kind of how it fits in our business.

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Operator [42]

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And our next question comes from Matthew Mishan from KeyBanc.

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Matthew Ian Mishan, KeyBanc Capital Markets Inc., Research Division - VP and Senior Equity Research Analyst [43]

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You've done a lot of work on pricing and elasticity of demand. How is that factoring in here? Is there a pricing headwind year-over-year? And are you getting the increased volume from a lower price point?

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Alison Perry Bauerlein, Inogen, Inc. - Co-founder, Executive VP of Finance, CFO, Corporate Secretary & Treasurer [44]

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Yes. So we are in Q2 lapping the pricing trial. So Q3 should be a clean quarter for us on a D2C pricing side versus what we saw in the prior year where we changed pricing in the middle of the second quarter of last year. We will continue to look at pricing over time. We'll do another pricing file at some point in time, but so far, pricing has not been a major concern on the D2C side because competitive products have not been priced at a discount to what we're currently offering.

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Operator [45]

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

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Scott Wilkinson, Inogen, Inc. - CEO, President & Director [46]

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Thank you. While this has been a challenging period for Inogen, we're committed to our mission of improving the freedom and independence of oxygen therapy patients. And we're focused on increasing our sales force, enhancing sales force productivity and helping our home-care partners overcome their restructuring challenges. I also want to reiterate, we're excited about the New Aera acquisition as we believe it allows us to maintain our market leadership position, while also allowing us to expand into new adjacent market opportunities, to meet our goals and execute on our plan to return to double-digit revenue growth in 2020. Thank you for your time today.

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Operator [47]

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Ladies and gentlemen, that will end today's conference call. We thank you for joining. You may now disconnect your lines.