Inogen Inc (INGN) 2015 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Inogen 2015 fourth-quarter financial results conference call.

(Operator Instructions)

As a reminder, this call is being recorded. I would now like to introduce your host for today's conference, Mark Klossner, Investor Relations. Please go ahead.

Thank you for participating in today's call. Joining me from Inogen is CEO Ray Huggenberger, President and COO Scott Wilkinson; and CFO and Co-Founder Ali Bauerlein. Earlier today, Inogen released financial results for the fourth quarter and year end December 31, 2015. This earnings release, and Inogen's corporate presentation, are currently available in the investor relations section of the Company's website.

During the call, and the subsequent Q&A session, we will be discussing plans and projections for our business, future financial results, and market trends and opportunities. Including, among others, statements regarding future product releases and improvements, product launch date expectations, our strategic focus and objectives, hiring expectations, seasonality, our estimates on the impacts of reductions in Medicare and insurance reimbursement rates, and changes to the competitive bidding process. Cost reduction expectations, expectations for private label sales growth, and 2016 guidance, including revenue, adjusted EBITDA, adjusted net income, net income, net cash flow, effective tax rates and tax benefits.

These statements are forward-looking, and are subject to substantial risks and uncertainties that may cause actual events or results to differ materially from currently anticipated events or results. Information on these and additional risks, uncertainties, and other information affecting Inogen's business operating results are contained in Inogen's annual report on form 10-K for the year ended December 31, 2014, and in Inogen's subsequent reports on form 10-Q and form 8-K. Additional information will also be set forth in Inogen's annual report on form 10-K, for the year ended December 31, 2015, to be filed with the Securities and Exchange Commission.

We advise investors to review these risk factors carefully. The forward-looking statements in this call are based on available information as of today's date, March 14, 2016, and we disclaim any obligation to update any forward-looking statements, except as required by law. During the call, we will also present certain financial information on a non-GAAP basis. Reconciliations between US GAAP and non-GAAP results are presented in tables accompanying our earnings release, which can be found in the investor relations section of our website.

I will now turn the call over to Ray Huggenberger. Ray?

Thank you, Mark. Good afternoon, everyone, and thanks for joining our fourth-quarter 2015 conference call. On our call today, I will start with the financial and business highlights, then Scott will cover our recent operational accomplishments, and then Ali will review the fourth-quarter 2015 financials in more detail, as well as provide our updated 2016 guidance. I'll close with remarks on our 2016 strategy, and then we'll open the call up for your questions. In the fourth quarter of 2015, demand for our portfolio of innovative oxygen concentrators remained strong across all of our revenue channels, and exceeded our expectations.

We historically have experienced some slower seasonal impact in the fourth quarter of the year, due to holidays and weather. However, demand in our domestic and international business-to-business sales channels, as well as the positive impact on our direct-to-consumer channel from investments made to expand our sales team, drove stronger than anticipated growth. Revenues in the fourth quarter were $40.4 million, which represented 38.9% growth from the same period last year. For the full year 2015, revenues were $159 million, reflecting 41.3% growth year over year.

Domestic business-to-business sales exceeded expectations, and continued to be our strongest growth channel in the quarter, increasing 81.5% over the same period in the prior year. We believe the strength we saw in this channel came from several factors, including private label sales, which contributed to more than half of the increase of this channel in the fourth quarter of 2015, over the same period in the prior year. Private label sales did not begin until early 2015, so year-over-year comparisons reflect that additional contribution. We are optimistic that this private label business relationship will continue to provide revenue contributions in our domestic business-to-business channel.

Increasing reseller demand was also a contributor to domestic business-to-business sales growth, as our partners have performed well in expanding their sales and marketing efforts. We also believe there's a likely pull-through effect, from our direct-to-consumer media campaigns, that demonstrate the benefits of our portable oxygen concentrators. Internationally, we saw stronger than expected sales growth in the fourth quarter of 2015 over the fourth quarter of 2014. This is particularly notable in light of the tough comparison, due to French and German reimbursement for Inogen One G3, that provided upside in the fourth quarter of 2014.

Sales in Europe represented 89.5% of our total international sales. We plan to continue to focus expanding international distributor and key account partnerships, as well as directly supporting larger customers throughout Europe, to drive conversion from the traditional delivery based systems to our portable oxygen concentrators. US direct-to-consumer sales and rental revenue in the fourth quarter of 2015 combined increased 34.1% over the fourth quarter of 2014, and represented 57.2% of our total revenue. Our strong direct-to-consumer sales in the fourth quarter of 2015 highlights the strength of our direct-to-consumer marketing model.

Due to the anticipated reductions of Medicare reimbursement rates in 2016, we will continue to shift our emphasis toward a sale over a rental. The growth in our direct-to-consumer channels was primarily due to our expanded in-house sales team, as well as growing brand awareness. You will recall that in the third quarter of 2015, we made the decision to accelerate our pace of hiring, as we felt it was an opportune time to make investments to further increase our direct-to-consumer sales force to capture the demand we expect this year and beyond. We continued to see qualified candidates throughout the remainder of 2015, and were successful in increasing our internal sales representative head count to 166 by year end.

That represents a 28.7% increase from December 31, 2014. Even with the increased investment in sales personnel and product development, we still improved profitability and delivered adjusted EBITDA of $8.1 million, and net income of $3.9 million, for the fourth quarter of 2015. For the full year 2015, adjusted EBITDA and net income were $32.3 million and $11.6 million, respectively.

Let me turn to some product updates. Maintaining our leadership position in the portable oxygen concentrators space, through a commitment to innovation and new product development, is a key strategy for us. We plan to continue to make R&D investments, to stay at the forefront of patient preference and product capabilities. The release to market of our enhanced Inogen One G3 portable oxygen concentrator was a highlight in the fourth quarter, as its upgraded features have the potential to serve more patients than the prior design. And the final design of our fourth generation portable oxygen concentrator, the Inogen One G4, is on track, with commercial launch planned for the second quarter of 2016.

I would now like to turn the call over to Scott Wilkinson, to cover our operational highlights. Scott has been with Inogen since 2005, and has served as our Executive Vice President of Sales and Marketing since 2008. He was promoted to the role of President and COO in January of 2016. Scott?

Thank you.

As Ray mentioned, we are committed to continuous product innovation and maintaining our leadership position, by delivering the best portable oxygen concentrators we can to the market. Our recently released upgraded Inogen One G3 provides five flow settings and a 25% increase in total oxygen production, with no added size or weight, giving it the highest oxygen output of any portable oxygen concentrator of the same weight in the market today.

In addition to increased oxygen production, the sound level of the Inogen One G3 has been lowered from approximately 42 decibels to 39 decibels, and the product cost was also reduced. Shipments of the upgraded Inogen One G3, and our direct-to-consumer sales and rental channels, began in December 2015 at product launch. In the first quarter of 2016, we expanded to sell the upgraded Inogen One G3 product through our domestic and international business-to-business channels.

Our Inogen One G4 is expected to be smaller, lighter, and less expensive to manufacture than our current Inogen One G2 and G3 products. We are excited about this product launch, as we believe it will provide the opportunity to increase freedom and mobility to millions of oxygen patients worldwide.

I would also like to comment on some reimbursement updates. We have not received additional information from CMS on the single payment amounts associated with the round two re-compete, which will be applied to approximately 50% of the Medicare markets on July 1, 2016. This will also have an impact on the amounts paid in the approximately 40% of the markets covered in the national application of competitive bidding rates that began in January of 2016. In January of 2016, the rates to apply to the areas that weren't subject to competitive bidding were calculated using the average of 2015 Medicare standard allowables, and the existing regional average single payment amounts, based on round one and round two competitive bid areas.

In July of 2016, the rates will be recalculated, based on the existing regional average single payment amounts, based on round one and the updated round two rates. We continue to expect the total revenue headwind in 2016 associated with these Medicare reimbursement rate reductions to be 2.5% to 3.5%. As we receive more information from CMS, we will provide updates as necessary.

In addition, it's been proposed to subject stationary oxygen services through a prior authorization requirement for Medicare patients. This is not unique to portable oxygen concentrators, but if this is enacted, we would be subject to this requirement. We do not know when or if this will be implemented, but it could create a small delay in processing new Medicare rentals, depending on the length of time it takes to get prior authorization. We already procure the necessary documentation to meet Medicare requirements before we deploy equipment to our patients, so this is already part of our intake process. In the long run, if this is implemented properly, it could be beneficial, as we could reduce denials currently received post-billing.

Moving to a quick regulatory update, in March 2016, an inspection was conducted by the FDA at our California facility. Their audit scope included reviewing our manufacturing procedures and equipment maintenance records, customer complaint handling procedures, the corrective action program, and the design control process. We're pleased to report that there were no findings reported to us during this inspection. We continue to strive to maintain strict compliance with the FDA regulations, and to continuously improve our quality and manufacturing processes.

I'll now turn the call over Ali, to cover our financial performance and guidance.

Thanks, Scott, and good afternoon, everyone.

During my prepared remarks, I will review the details of our fourth-quarter financial performance, and then I will provide updated guidance for 2016. As Ray noted, total revenue for the fourth quarter of 2015 was $40.4 million, representing 38.9% growth over the fourth quarter of 2014. We saw better than anticipated revenues in a historically seasonally slower fourth quarter. Looking at each of our revenue streams, and turning first to our sales revenue, total sales revenue was $28.9 million, reflecting 57.7% growth over the same quarter of the prior year, and representing 71.6% of total revenue.

Total units sold increased to 14,500 in the fourth quarter of 2015, up 62.9% from the fourth quarter of 2014. Domestic business-to-business sales were $8.9 million in the fourth quarter of 2015, and it was our fastest growing channel in the quarter, with a growth rate of 81.5% over the same period in the prior year, primarily due to increasing private label and reseller demand for our portable oxygen concentrators. International business-to-business sales exceeded our expectations, at $8.5 million, representing 21.2% growth versus the same period in the prior year, primarily due to continued strong demand from our European partners.

International average selling prices in the fourth quarter of 2015 declined over the same period in the prior year, due to currency headwinds and additional discounts associated with the increased sales volume. Direct-to-consumer sales for the fourth quarter of 2015 were $11.6 million, representing 79.5% growth over the fourth quarter of 2014, primarily due to the increased inside sales headcount, as the staff added in the fourth quarter of 2014 began to contribute meaningfully in the second half of 2015.

Now, I'm turning to rental revenue. Direct-to-consumer rental revenue in the fourth quarter was $11.5 million, representing 6.8% growth over the same period in the prior year. Rental revenue represented 28.4% of total revenue in the quarter. We continue to shift sales focus towards consumer sales versus rentals, primarily due to the anticipated additional Medicare reimbursement cuts in 2016. Rental revenue in the fourth quarter of 2015 was relatively flat, when compared to the third quarter of 2015. This is primarily due to lower rental revenue per patient on service. At the end of the fourth quarter of 2015, we had 32,800 rental patients on service, a 15.5% increase over the number of patients on service as of December 31, 2014, and a 1.2% increase over the number of patients on service as of September 30 of 2015.

Turning to gross margin. For the fourth quarter of 2015, total gross margin was 49.5%, compared to 47.4% in the fourth quarter of 2014, up approximately 210 basis points. Our sales gross margin was 48% in the fourth quarter of 2015, versus 43.7% in the fourth quarter of 2014. The improvement in sales gross margin percentage was primarily related to a shift in sales mix towards higher margin direct-to-consumer sales, which accounted for 40% of total sales revenue in the fourth quarter of 2015, versus 35.2% in the fourth quarter of 2014. As well as a reduction in cost of goods sold per unit stemming from lower materials, labor, and freight costs. Combined, these two factors were the primary enablers to more than offset the decline in business-to-business average selling prices. Rental gross margin was relatively stable at 53.4% in the fourth quarter of 2015, versus 53.8% in the fourth quarter of 2014. Lower service costs per rental patient enabled us to mostly offset lower net revenue per rental patient.

In terms of operating expenses, operating expense was $16.6 million in the fourth quarter of 2015, versus $12.4 million in the fourth quarter of 2014. The increase was primarily due to strategic investments made in additional sales service head count and support personnel. Operating expense as a percent of revenue decreased to 41% in the fourth quarter of 2015, from 42.5% in the fourth quarter of 2014, as we continue to demonstrate our ability to achieve operating leverage. For research and development expense, we had $1.2 million in R&D expenditures for the fourth quarter of 2015, versus $0.7 million in the same 2014 period.

The increase was primarily associated with additional personnel and engineering product development expenses, primarily related to the Inogen One G3 upgrade and the Inogen One G4 development. For selling, general and administrative expense, or SG&A, total SG&A expenses increased 30.9%, to $15.3 million, in the fourth quarter of 2015, versus $11.7 million in the same 2014 period, primarily due to the additional investments made in 2015, in sales and support staff, that we expect will facilitate our growth in 2016 and beyond.

Sales and marketing expense was $8.7 million for the fourth quarter of 2015, versus $6.4 million in the same 2014 period, primarily due to increased direct-to-consumer sales force addition, customer and clinical services personnel, and media expenses. General and administrative expense was $6.6 million for fourth quarter of 2015, compared to $5.3 million in the same 2014 period. The increase was primarily related to increased personnel and bad debt expense.

In the fourth quarter of 2015, we recorded an income tax benefit of $0.5 million, compared to a benefit of $0.2 million in the fourth quarter of 2014. in the fourth quarter of 2015, our effective tax rate was negative 16.3%, primarily due to the tax benefit adjustments of $1 million, mainly related to a decrease in the valuation allowance related to California net operating losses, and an increase in equity compensation deduction. Excluding these tax benefit adjustments, the effective tax rate for the fourth quarter of 2015 would have been 14.3%, which was lower than the rest of 2015, primarily due to benefits associated with the federal R&D tax credit and the timing of stock dispositions in the fourth quarter of 2015.

As a result, our net income in the fourth quarter of 2015 exceeded expectations, primarily due to strong revenue, improved gross margin, and a lower effective tax rate. Net income for the fourth quarter of 2015 was $3.9 million, compared to $1.5 million in the fourth quarter of 2014, an increase of 154% in the comparative period, and representing a return on revenue of 9.5%.

Earnings per diluted common share was $0.19 in the fourth quarter of 2015, versus $0.07 in the fourth quarter of 2014, an increase of 171.4%. Earnings per diluted common share for the full year 2015 was $0.56 versus $0.30 for the full year 2014, an increase of 86.7%.

Moving to our cash balance, we ended 2015 with $82.9 million of cash, cash equivalents and short-term investments, an increase of $8.8 million from September 30 of 2015. In the fourth quarter of 2015, we made investments in property and equipment of $2.7 million, primarily for our rental fleet addition. As of the end of the fourth quarter of 2015, we had no bank debt outstanding, and our entire $15 million credit facility was available.

In addition, I would like to cover some key non-GAAP financial measures. Adjusted net income in the fourth quarter of 2015 rose 125.5%, to $2.8 million, from $1.3 million in the fourth quarter of 2014. The tax benefit adjustments excluded from adjusted net income were $1 million in the fourth quarter of 2015, versus $0.3 million in the fourth quarter of 2014.

Adjusted EBITDA for the fourth quarter of 2015 was $8.1 million, which was a 20.1% return on revenue. Adjusted EBITDA increased 63.8% in the fourth quarter of 2015, versus the fourth quarter of 2014, where adjusted EBITDA was$ 5 million.

Turning to guidance, we are providing updated guidance for the full year 2016. We now expect total revenue of $187 million to $191 million, representing 17.6% to 20.1% growth over the 2015 revenue of $159 million. This compares to prior guidance of $177 million to $183 million. This revenue growth is in spite of the additional revenue headwinds expected in 2016, associated with the national application of competitive bid prices to Medicare areas currently not subject to competitive bidding. We continue to expect total revenue headwinds from Medicare competitive bidding national rollout of 2.5% to 3.5% in 2016.

While we do not provide quarterly guidance, we should note that we historically experience a seasonally slower Q1 and Q4, with higher Q2 and Q3, resulting from the warmer months, and when patients are more likely to travel, and we expect similar trends in 2016. However, due to the anticipated timing of the Inogen One G4 launch in the second quarter, and the full impact of the reimbursement changes that become effective in the second half of this year, we could see even more pronounced seasonality in 2016.

We expect direct-to-consumer sales to be our fastest growing channel in 2016. Adjusted EBITDA guidance for 2016 is $37 million to $39 million, representing an increase of 14.6% to 20.7% over 2015. We are basing this anticipated result on several factors, including increasing direct-to-consumer sales as a portion of total revenues, as investments in our sales force produce returns; lower cost of goods sold following the launch and rollout of the Inogen One G3 upgrade and the Inogen One G4 products; and continued operating expense discipline. We expect these factors will mostly offset the reimbursement declines expected in the Medicare market, on an adjusted EBITDA and net margin basis.

Adjusted net income is expected to be $12 million to $14 million, representing 19.8% to 39.8% growth over 2015. Net income guidance for 2016 is $12 million to $14 million, representing an increase of 3.6% to 20.8% over 2015. We expect an effective tax rate in 2016 of approximately 35%, compared to an effective tax rate of 32% in 2015, excluding the tax benefit adjustments of $1.6 million that are not expected to recur in 2016. We expect a higher effective tax rate, primarily due to lower tax deductions for equity compensation as a percentage of pretax income, which is not expected to have as much impact on the 2016 effective tax rate as it did in 2015.

We also expect a higher effective tax rate in the first half of 2016, versus the second half of 2016. In addition, we continue to expect net positive cash flow for 2016, with no additional equity capital required to meet our current operating plans.

I'd now like to turn the call back to Ray for some closing remarks.

All right. Thanks, Ali. I'll close with just a few comments on our strategy for 2016. We will continue to seek ways to mitigate the impact of reductions in our rental reimbursement business, resulting from the anticipated changes that emerge from competitive bidding later this year, including the ongoing shift in emphasis towards cash sales. During 2016, we expect to commit further resources to increasing our sales force, as we identified qualified candidates, while at the same time ramping marketing programs to educate physicians and patients alike on the benefits of POCs.

Finally, we expect to launch our new Inogen One G4 in the second quarter of 2016, as well as continue to advance innovation and product development. In addition, we plan to continue to identify additional deficiencies, to reduce our cost of goods sold per unit and increase overall operating expense leverage, in order to preserve net adjusted EBITDA margins.

With that, Scott, Ali and I would now be happy to take your questions.

(Operator Instructions)

Our first question comes from the line of Mike Weinstein with JPMorgan. Your line is open. Please go ahead.

Thank you and congratulations, guys, on another very nice quarter. Let me ask you, you're now 2 1/2 months, basically, into the new year. And when you initially gave your 2016 guidance, really, part of the message was, we really need to see how the B2B business was going to continue to play out. It obviously did much better than expected in 2015. But you said let's just be cautious, going into 2016, because we just don't know how much is going to repeat, and whether we can continue to expect to see such great growth. Now that we're 2 1/2 months into the year, do you have any incremental insights? And how do you think about the B2B business, and I mean both the US and international for 2016?

Yes, sure, Mike. I'll take that question. First of all, just talking a little bit about 2015, obviously, it was a great year for us. Domestic business-to-business increased a little over $15 million. And the majority of that was associated with the addition of the private-label sales that had no base in 2014, because we didn't start that until the first quarter of 2015. So while that was a great growth driver for us in 2015, when we look at 2016, we think that growth rate of domestic B2B will slow substantially, because of that year-over-year comp, and that's the private-label sales going into the baseline.

We still, with business-to-business in general, have less visibility, and the same thing with international. International increased almost $11 million, year over year, in 2015 versus 2014. And a large driver of that was the additional reimbursement that we got in France and Germany for the G3 product, in the second half of 2014. And also discontinued strong relationships and partnerships with distributors and the large gas companies, primarily in Europe. When we look to 2016, international growth rate is the hardest for us to predict, because we are dependent on the success of our partners, and how they deploy POCs.

We also, looking at 2016, don't expect that Inogen One G4 product to have a significant impact in the international markets until 2017. Because they typically go through a longer product review cycle, as well as the additional regulatory requirements to get it approved in the various markets. So internationally, we expect the driver to still be the Inogen One G3 upgraded product. And when we talk about guidance, and the guidance range that we have given, it really is still assuming that direct-to-consumer cash sales will be our fastest growing channel for 2016, because that is where we have the most control, and we've assumed lower growth rates for both domestic and international, versus the direct-to-consumer areas.

We have not assumed any material new market or reimbursement decision in the guidance, and we've also not assumed any large national adoption, or any additional private-label relationship. Those would be accretive to guidance. And clearly, until we have visibility on those things, it wouldn't be prudent to include those in guidance.

Understood. Let me ask you this, relative to G4, and I'm thinking back to when you guys launched G3. And one difference at this point is -- there's a few differences, but obviously, your sales force is much larger today than it was when you launched the G3 product. You're in a completely different place, and the B2B business is obviously much more developed. Can you just talk about how you think about that launch, versus what we saw when you launched G3?

Yes, this is Scott, I'll take that one. I think you'll see a similar trend in process, as with previous launches, if you look at G3 compared to G2. We have got a product that's smaller and lighter, and I'll say more patient preferred, so we expect positive things from that. But when you look at the transition, we always start with a new product, and we have got a formula that's tried and tested. It's worked for us. We start with the consumer channel. We sell directly to the consumers with our in-house sales team.

Once we've scaled our manufacturing to a point where we're comfortable, we'll go to the next phase. That will be the business-to-business channel. That includes both the home-care companies, as well as the Internet resellers. And then the last phase in expansion would be the international markets. And as Ali just mentioned, in international markets with new products, there's typically a lot more testing required for product adoption.

Country by country, sometimes we have to seek reimbursement in those countries. So international tends to be a little bit slower adoption, and it's at the end of the curve. But I think, given that this is our fourth product launch, we feel pretty comfortable with what's going to happen. It's reflected in our guidance for this year, and we're still on track for a second-quarter launch for G4.

Scott, the 183 internal reps you have as of year end, what percentage of those have been on for less than six months?

(Multiple speakers) I'm sorry?

I'm thinking about the productivity of the new-rep hire. So the 183 internal sales reps you have now, what percentage of them have come on recently? Essentially, I used the time frame of the last six months. Do you have a sense for that?

Yes, so just to clarify, we have 166 reps. The 183, that includes sales management and admin support, et cetera. So it's 166 internal reps. As we have mentioned in the past, we did a ramp-up in hiring in the second half of last year, so it wasn't linear, our adds last year. There are still reps coming up the curve that we added in December, and it's a four to six month ramp to a steady state for reps. So we've still got those reps added at the tail end of last year that are coming up the curve.

If you look at productivity improvements, generally, there are some small productivity improvements across the board. We try and drive efficiency year over year, but you've also got to remember that, from a Medicare standpoint, they usually throw some more curve balls at you. So we try and offset those curve balls with the productivity improvements.

Now, going into the second quarter, as Ali mentioned, from a seasonality standpoint, every year is our high-water mark. So we're going to be launching a G4 in a period that is, from a seasonality standpoint, usually our best time of the year. We'll see how things will play out. But it will be -- it's difficult to sort out the impact of G4 seasonality and new reps, because they're all in that mix. But it's a good time to be launching a new product, in our best time of the year.

Understood. Okay. I'll ask one last question, and I'll let somebody else jump in. Ali, the sales mix was pretty comparable, 3Q to 4Q, but your sales gross margin was about 300 basis points higher. Why was that?

Yes, so the big driver, when you look at it, is we have talked about lowering our cost to goods sold. And that is something that was a driver in the fourth quarter versus the third quarter, with the launch of the upgrade to the Inogen One G3 product, as well as continued savings on our labor and freight side. So outside of just sales mix, lower cost to goods is the primary driver.

Okay. Great. I'll let some others jump in. Thank you, guys.

Thank you. Our next question comes from the line of Margaret Kaczor with William Blair. Your line is open. Please go ahead.

Good afternoon, guys.

Hi, Margaret.

Hey, Ray. So the first question that I have is on the sales force and sales force productivity piece. And I know, Scott, you just addressed it a little bit, but again, your productivity seemed to improve in 2015 over 2014. Why shouldn't we expect productivity increase again, as you guys launch the upgraded G3, the next gen G4, both of which should improve your close rates?

And then, even with the changes that you guys had discussed earlier on the DTC sales over to rental, as that reimbursement gets pushed out, that should drive more DTC sales. And again, Scott, I know some of that gets offset with reimbursement cuts, but you do get more front-end revenue by moving over there. And then just to wrap it all up, I guess, with the sales reps up 30%, why shouldn't we see DTC growth be over 30%?

Yes, Margaret, you've got to remember, if you look back over the last couple years, that we have migrated in a shift towards emphasizing cash sales away from rentals, to better diversify away from the Medicare reimbursement reduction. So as you get a cash sale, you get all of the revenue up front, versus, on a rental sale, that payment comes over two years or more. So you inherently, if you just study the financial numbers, you'll see what could look like a productivity improvement in financials, driven by the direct-to-consumer channel, that really is more of a shift of migrating to the cash sales.

Hopefully, that makes sense, just because of the front-end loading of every cash sale that you get, versus the impact on a rental sale. Certainly, we expect, from a G4 standpoint, we expect that to be, I'll call it, a more preferred product, from a patient perspective, versus previous versions of the product. Our studies have shown, and it's not rocket science, that patients like smaller, lighter things that are easier to carry. And a smaller and lighter POC is, we have launched version after version, the smaller and lighter we go, the more success that we've have.

So we certainly expect that G4 is going to be patient preferred, and will be our flagship product in our line. It doesn't necessarily open up the market, per se, as far as number of patients, but it will make conversion, we expect, perhaps a little bit easier. There's patients that maybe, in the past, would have said, a G2 or G3 might be a little heavy. Now, with the smaller, lighter product, it could be a product where they say, now I'm going to make the change. But time will bear that out. We don't have the product in the market yet, so we'll have to see what happens once we launch.

Yes, and just to expand a little bit on that, we're saying, at the midpoint, it's about a 19% increase in revenue. So -- and we're also saying that direct-to-consumer cash sales will be our fastest growing channel of that, and you're offsetting a pretty significant reimbursement decline. So not to say specifically what we expect, in terms of the growth rate of that direct-to-consumer channel, but in order for the numbers to work out, it has to be faster than 20%.

So in that, 20% to 30% is certainly feasible. A lot will also have to do with the timing of when the Inogen One G4 is launched, in terms of earlier or later in the second quarter, since there is a ramp-up period, and you're hitting right at peak seasonality. So it can have a big impact on how many G4s you're really getting at the peak seasonality, which could have an impact on our overall direct-to-consumer growth rate for the full year.

Sure. No, that's helpful. And Scott, I meant more on a revenue per rep, rather than a patients added per rep, but I guess both may go hand in hand. And then, just to move to gross margins, and follow-up on something Mike had asked, how much of the improvement due to product was a matter of mix and launching that upgraded G3 device? And maybe another way of saying that is, how many of the upgraded G3 devices did you sell, versus the older devices in the quarter? And then as round three gets implemented, with the G4 coming out in 2016, how does that play out, net-net, for gross margin, as we look out?

Yes, so we didn't break out specifically what the contribution was, of cost-to-goods sold versus the other drivers. The upgraded G3, as you recall, was just launched in December, so it did not have the full impact. And it was only launched in the direct-to-consumer cash sales segment, so it was not included in any of the business-to-business sales. So the volume was certainly lower than what you would expect to see on a full quarter. But when you look at cost-to-goods sold, and the reductions we have seen, it's a combination of lower product cost and lower labor cost and freight costs. So the labor costs and freight costs are seen across all of our products, not just the upgrade to the G3.

When we look at 2016 and that gross margin, obviously, we don't give gross margin guidance, as it really is very sales mix dependent. We do expect that the launch of these products, both the upgraded G3, as well as the upcoming G4, as well as continuing to focus on cash sales, will mostly offset the reimbursement decline on that adjusted-EBITDA margin basis that you see in our guidance, that we're offsetting that. But we don't give specific gross margin guidance. And obviously, there are a lot of moving parts this year, with both improving sales gross margin and declining rental gross margin.

Okay. And then the last one for me is maybe a more strategic one for Ray. Ray, how do you see the role that ATIT has in next-generation devices, whether it's product differentiation? Maybe what advantages or disadvantages do you guys have in the ATIT ball game, given your exposure to the consumer segment? And you guys are also an HME, so how would you use it as an HME? Can you save further costs? Maybe you guys know more than some of the other new players that don't have the advantage of being a manufacturer as well as an HME. Thanks.

Okay. Yes, there are like three questions somehow in there, so I'm going to try to pull them apart, because they require different answers. Start with the private label first. Right now, we're very happy with our private-label relationship. It has clearly exceeded our expectations in its first year, and at this point, we're not really out there proactively seeking other partners. And if opportunities present themselves, we would carefully consider and weigh the pros and cons, and carefully consider if we would enter into another relationship, provided that this partner would be reaching beyond the capabilities of our existing partnership. So that's the private label.

Relative to us using the G4 or the G3 as a DME provider, it's really no different than what we would see most DME providers, if they decide to switch to oxygen business to POCs. We don't really see that we are operating fundamentally different than we would see those other DME providers operate. And the formula has been, over the last four or five years, has been refined and fine tuned, and it is working for us. And there is no magic bullet that we have that couldn't be used by other DME providers, assuming that they switch their modality to POCs, and take the subsequent action of managing their infrastructure cost out.

Great. Thank you.

Thank you. Our next question comes from the line of Danielle Antalffy with Leerink Partners. Your line is open. Please go ahead.

Good afternoon, guys, thanks so much for taking the question. Just wanted to dig a little bit deeper into the sales-rep productivity. Clearly, it was better in the quarter. Curious if you can quantify how much of the beat was due to higher rep productivity, versus new rep adds?

And then, in that same context, as we think longer term, with each quarter that you guys deliver a strong beat, how do you think about long-term rep productivity? I assume, does the bar continue to move higher? Or do you still feel like your reps level off? I guess I'm trying to get a sense of how much incremental leverage is left in the existing rep base versus revenue growth, going forward, needing to be driven by new bodies in the seats, or more bodies in the seats?

Yes, let me tackle your -- I'll say the historical productivity question first. So last year, as you know, we added a significant amount of reps. It was very back-end loaded. At the same time, throughout the year, we continued to emphasize cash over rentals. So you've got two things moving at the same time last year. Both of those have a contribution to the productivity of that entire sales force.

Now, migrating to cash has a productivity impact on a per-rep basis. Obviously, adding more reps doesn't have any impact on a per-rep basis. But both of those things have an impact on the output of that sales team and our results throughout the year, and particularly in the fourth quarter, because the additions were back-end loaded. I'll just say that both of them have an impact. We don't really break out which one has a greater impact, but I'll say that both have an impact that is noticeable, both the adds and migrating to cash.

Okay.

If we look ahead this year, we'll continue to add reps this year. One of the things that we'll do, it will be, at least our plan is to have it be less lumpy than it was last year. We would like to add the reps in, I'll say, a more linear fashion throughout the year. A lot of it depends, though, on if we're able to find reps that meet our qualifications. So that's one of the keys, as far as if we're going to add reps or not. They have got to meet our criteria.

We will continue to drive productivity improvements throughout the sales team. That's part of one of our core values in the Company is continuous improvement. But as you might expect, we're in year 6, 7 of this program, and I'll say a lot of the low hanging fruit, as far as productivity improvements, have already been rinsed out. So the amount of those productivity improvements, on a percent basis year over year, they get a little smaller each time around. But it should be greater than zero, and our expectations are that they're greater than zero, from a productivity improvement standpoint.

Yes, one thing I would just add to that, because I want to be a little careful here on assuming what we did in the fourth quarter of 2015 is repeatable, going forward. I want to remind people what happened in the fourth quarter of 2014. In the fourth quarter of 2014, if you recall, that's when we added a significant number of sales reps for 2014. And so we had, all throughout 2014, up until the fourth quarter, our sales reps were actually slightly declining, with just normal attrition.

And then we had the big hire round in the fourth quarter, which increased our sales rep staff, year over year, and allowed us to really drive into 2015. So the comp was particularly easy for us versus the fourth quarter of 2014, when we had significantly fewer seasoned, fully trained reps. Versus where we are now, with the fourth quarter of 2015, where you have both the productivity of the fourth-quarter 2015 adds, as well as starting to ramp up the reps that we have added throughout 2015, particularly the third quarter of 2015. Those reps really did contribute in the fourth quarter of 2015, as well.

So there is also a comparison factor here, that the fourth quarter of 2014 was a particularly easy comparison for us, and was one of our slower growth rates in the fourth quarter of 2014, was that direct-to-consumer sales, because of the factors of the sales force. So that always needs to be taken into account when you're looking at the year-over-year increase.

Okay.

And I want to make sure that what Scott said earlier doesn't fall by the wayside. And that is, when you replace a rental with a cash sale, your revenue productivity of that rep automatically goes up. The number of units that they sell may not go up, but the revenue productivity of that rep goes up, because you're recognizing the entire revenue at the time of sale, not over the next two years.

Okay.

And there is a limited amount of airspace that we can push the cash sales, where we can push rentals to cash, and we're getting -- the air is getting a lot thinner. So I wouldn't use historical numbers to extrapolate for the future, because clearly, the fruits, the low hanging fruit were much more bountiful one or two years ago.

Okay. Great. That's really helpful color. And then, Scott, I think you touched on it in your prepared remarks, but just as it relates to the prior authorization. So you mentioned the impact in delaying processing. But how do we think about that translating into revenue? And what's baked into the current, newly raised 2016 sales guidance?

Yes, it's hard to say, because they haven't even rolled out the definition of the program yet. It's in phases of discussion. I think the good news for Inogen is that our policy has always been that we collect everything that we needed up front, before we deploy product for a patient. So we don't really see this as a big curve ball for us.

Now, where it will be a curve ball is for the patients, because the patients are going to have to wait on the response from CMS to get an answer on whether they qualify or not. And that's who will be squeezed in the middle. But for us, our policies already fall right in line with that, for the most part. But to comment further, we need to have some definition on exactly how they're going to roll the program out, and we don't have that yet.

Yes, and just to be clear, obviously, this only impacts the Medicare business. A portion of the private insurance is, we already go through the prior-auth process, depending on the insurance company. So it would be incrementally, the Medicare business, which is about 21% of our total business, that could be subject to this prior authorization. And because we already get all of the documentation, and feel like these would be good claims, it's just a matter of now getting this additional step.

We don't think it would change, materially, the number of new rental patients that we would add in a period. And because so much of the rental revenue that you generate is associated with patients you already have on service, and the new patients contribute a very small amount, when you look at total revenue dollars, I don't think it will be material either way. You may see it in a specific quarter that it's implemented, that the net new-patient set ups are slightly lower than what it would be without that. But I don't think that you'll really see any type of material impact on the rental revenue side, directly tied to a prior-authorization requirement.

All right, guys. Thanks for the color.

Thank you. Our next question comes from the line of Mike Matson with Needham & Company. Your line is open. Please go ahead.

Hi, thanks for taking my questions. I guess I just wanted to ask about the private-label agreement with Applied Home Healthcare. So if I'm doing the math correctly, based on what you said, I think it would have added about $2 million into your sales in the quarter. So one, is that correct? And then two, do you have a sense for how much of that reflects what they actually sold in the quarter? Or is some of that like a stocking order or something?

Yes, so on the first statement, basically, what we said was the majority of the increase. So that's about $2 million at the bottom end. We haven't given a specific number of what it could be, but obviously, the total increase in the quarter was about $4 million. So it's anywhere from $2 million to $4 million would be the contribution of that business.

We don't believe that there are any specific stocking orders that we're aware of. It's very quick delivery that we do with the private-label partner, and so we have no reason to believe that. Although what you don't know, with any private-label partner, is not what they stock, but what their customers stock. And that's where we have no visibility on those stocking levels, and if the product is truly being deployed into the channel or not.

Okay. Thanks. And then just on the round two re-bid. So I know you commented that you haven't yet seen the single payment amounts. But I'm just wondering, what is your assumption that you have baked into your guidance, around the decline that we would see? Are you assuming that it's flat or down slightly, versus the original round two? And then how big of a decline would we have to see, for it to cause you to lower your guidance?

Yes, so that is the reason why we give a range of total revenue headwind, of 2.5% to 3.5%, because we don't know. If it's flat, it's probably on the 2.5% side of total-revenue headwind. If it's a decline, depending on how big that decline, it could be as big as a 3.5% of the total-revenue headwind. That would have to be a pretty hefty additional decline, though, just given that Medicare is only 21% of our total business.

So we feel like the rates should come within that range. Obviously, we have no visibility on what those rates are, or when they will announce them. They did say that they would be coming in winter of 2016, and it feels like we're nearing the end of winter 2016. But of course, we don't have information at this point.

Okay. Thanks. And then just on the -- I think, Ali, you made a comment about some increased bad-debt expense. I was wondering if you could just explain that?

Yes, so we did have a slight increase in bad-debt expense in the period. It wasn't particularly strong, on a total-dollar basis. If you look at total-bad-debt expense as a percentage of total revenue, for the year of 2015, it was 1.7%, compared to 1.5% in the year ended 2014. So it was up slightly. Both of those were down from 2013, where we saw bad-debt expense of 2.7%. In the fourth quarter specifically, our bad-debt expense was about 2.1% of total revenues, versus 1.7% in the fourth quarter of 2014. So it was a slightly bigger impact in the quarter comparison, year over year, although we still think it's reasonable levels, given our business.

Okay. That's all I have. Thank you.

Thank you.

Thank you, and our next question comes from the line of Tom Carroll with Stifel. Your line is open. Please go ahead.

Thanks. Just to follow up on the prior-authorization comments, as well, do you think that, that potentially could be good for your D to C business, in that it's an additional Medicare hurdle that's not there today?

Yes, Tom, I think it could be. I wouldn't say that I think it will be. It could be. We'd have to wait and see. It certainly -- as you rightly pointed out, it's an extra hurdle for a patient to get product, or any oxygen equipment, deployed to them. And any time that there's a barrier, it could help our D to C cash business, yes.

Okay. Thank you. And then, how did your sales-rep attrition change for 2015? I think you said from 2013 to 2014, it was about 20%. Did that stay the same, go up, go down?

Yes, we didn't disclose the attrition for 2015. But we do expect, going forward, that we'll continue to see attrition at -- for the inside sales team at equivalent inside sales team types of attrition levels. So we don't expect to be materially different than (multiple speakers) --

Other call centers' sales teams.

Correct.

What was the 20% number you've given to us before, though? I think you mentioned a churn -- I think you called it a churn number in your sales reps?

We did mention attrition for 2014, of 22.1%.

Okay.

Previously, yes. We did disclose that previously.

So you're not disclosing it for 2015. Is that what you're saying?

We didn't specifically disclose it at this point.

But it hasn't changed materially?

We don't think that it's --

Since we're not disclosing it, we can't really say yes or no to that. (Laughter) The -- and Tom, if you look at call center sales forces and their attrition, attrition, clearly one of the issues that every call center sales force had, in every industry. The benchmarks hover somewhere between 20% and 30% or 35%.

Anywhere from the mid 20%s to mid 30%s is typical of a call center.

So in 2014, we actually were very proud of ourselves, because we did really well, relative to the benchmark. We decided not to disclose it, going forward. But what we're expecting, and what's baked into our forecast and our guidance, is that our attrition would be equal or no better, no worse than what the applicable benchmarks are.

Okay. Thank you.

Thank you. And I am showing no further questions at this time. I'd like to thank everyone for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.

Thank you.