Inogen Inc (INGN) 2016 Q1 法說會逐字稿

Good afternoon, and welcome to the Inogen 2016 first-quarter financial results conference call.

(Operator Instructions)

Please note this event is being recorded. I would like to turn the conference over to Mr. Mark Klossner. 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 first quarter ended March 31, 2016. 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 release specifications, product launch date expectations, our strategic focus and objectives, hiring expectations, seasonality, our estimates of the impact of reductions in Medicare and insurance reimbursement rates and our ability to offset those reductions, changes to the competitive bidding process, cost reduction expectations, expectations for profitability improvement 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, 2015 and in Inogen's subsequent reports on Form 10-Q and Form 8-K filed with the Securities and Exchange Commission, including Inogen's quarterly report on Form 10-Q for the period ending March 31, 2016 to be filed with the Securities Exchange Commission.

We advise investors to review these risk factors carefully. The forward-looking statements in this call are based on information available to us as of today's date, May 9, 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.

Management believes that non-GAAP financial measures, taken in conjunction with US GAAP financial measures, provide useful information for both management and investors by excluding certain non-cash and other expenses that are not indicative of Inogen's core operating results. Management uses non-GAAP measures to compare Inogen's performance relative to forecast and strategic plans to benchmark Inogen's performance externally against competitors and for certain compensation decisions. Reconciliations between US GAAP and non-GAAP results are presented in the 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 thank you for joining us for our first-quarter 2016 conference call. On our call today I will start with the financial and business highlights, then Scott will cover our recent operational developments, and finally Ali will review the financials and the2016 guidance. At that point we will open the call up for your questions.

Despite reimbursement headwinds, we had a solid start to 2016 with revenues of $43 million in first quarter which represented 27.4% growth from the same period last year. Notably, sales revenue grew 42.4% in the first-quarter 2016 versus the comparative period in 2015 and represented 76.3% of total revenue. The highest percent of total revenue in the Company's history, despite the first quarter being the seasonally weakest of the year.

Demand for our portfolio of innovative oxygen concentrators remained strong in both our business to business and direct to consumer sales revenue channels. This strong performance offset the anticipated rental revenue decline, primarily due to the reductions in Medicare reimbursement rates. Domestic business-to-business sales was again our strongest growth channel in the first quarter of 2016, increasing 61.2% over the first quarter of 2015.

We believe the strengths in this channel came from several sources. Led by private-label sales, which contributed to the majority of the increase in this channel in the first quarter of 2016 compared to the first quarter of 2015. As a reminder, private-label sales began on the first quarter of 2015, but were a very small contributor in the domestic business-to-business sales channels in that quarter.

Internationally, we saw good sales growth of 18.7% in the first quarter of 2016 compared to the first quarter of 2015 due to the continued strength in Europe with our partners in key accounts. Sales in Europe continue to represent the majority of international sales at 90.8%. We are seeing existing customers expanding their usage of our portable oxygen concentrators.

Direct to consumer sales was also a strong performer in the first-quarter of 2016, increasing 52.4% over the first quarter of 2015. This strength continues to validate the strategic investments we've made in expanding our direct to consumer sales force and our marketing efforts. As expected, direct to consumer rental revenue declined modestly in the first quarter of 2016 compared to the same period in the prior year, primarily as a result of Medicare reimbursement cuts.

In the first quarter of 2016 we delivered adjusted EBITDA of $8.1 million and net income of $2.4 million, showing that we can continue to deliver solid bottom-line results even in the face of reimbursement rate headwinds. A quick update on our strategic priorities. I am pleased with our momentum and as we continue to execute on our strategic objectives for 2016, we expect to launch the Inogen One G4 before the end of this month.

The Inogen One G4 is the latest of our product in the portable oxygen concentrators space. As Scott will describe later, we believe that Inogen One G4 offers unique features and benefits which will further improve the lives of many oxygen therapy users. We also plan to continue to add sales staff and develop additional innovative products.

At the same time, we plan to decrease our cost of goods sold per unit, increase the revenue mix of our direct to consumer sales, and improve operating efficiencies to further increase profitability with the goal of offsetting most of the effects of the expected Medicare rental reimbursement reductions on an adjusted EBITDA margin basis. We have shown solid progress towards these goals in the first quarter of 2016.

I would now like to turn the call over to Scott Wilkinson to cover our operational highlights. Scott?

Thank you, Ray. As a Company, Inogen is committed to product innovation. The improvements we recently made to our Inogen One G3 have received positive market acceptance, and this product is now available across all our sales and rental channels. We're very excited about the upcoming launch of the Inogen One G4 portable oxygen concentrator, which we believe will provide the opportunity to increase freedom and mobility to thousands of oxygen patients worldwide.

At approximately half the size, in the Inogen One G4 weighs only 2.8 pounds versus 4.8 pounds for our Inogen One G3 portable oxygen concentrator. The sound level is approximately 40 decibels at setting 2, and it produces up to 630 milliliters of supplemental oxygen per minute supplied through our intelligent delivery technology. We estimate that it will be suitable for more than 85% of the supplemental long-term ambulatory oxygen therapy patients who contact us.

The Inogen One G4 is not only smaller and lighter than our current Inogen One G2 and Inogen One G3 products, but it is also less expensive to manufacture. Shipments of the Inogen One G4 in our direct-to-consumer sales channel are expected to begin before the end of this month. Over time, we expect the Inogen One G4 to be our flagship product and our direct to consumer sales channel.

We will issue a press relates to announce the formal launch of the product. We expect to expand shipments to our domestic business-to-business channel in the third quarter of 2016. At launch, we do not plan to make the Inogen One G4 available for rental and we will continue to use the Inogen One G3 product as the primary product deployed in our rental fleet.

In 2016 in our international channel, we expect minimal sales of Inogen One G4 due to the timing of product regulatory and reimbursement approvals. We expect sales in this channel to ramp up in 2017. Initially we planned to price the Inogen One G4 at par with the Inogen One G3 in the direct to consumer channel.

We will be conducting a pricing study to determine our longer-term pricing strategy. In the first quarter of 2016, we continued to invest in expanding our sales force to increase our sales capacity and we plan to continue with our sales rep expansion activities throughout the year.

On the Medicare reimbursement front, we're working through the competitive bidding implementation process for the recently completed round two recompete. The contracting process has ended and the winning suppliers were announced in April 2016. In this process we were offered and have accepted respiratory contracts in 93 of the 117 round 2 recompete competitive bidding areas.

We are currently waiting for the results of the round 1 recompete for contracts that begin in January 2017. Bids have been submitted, and we expect receive the results by the end of the third quarter of 2016. We estimate that these competitive bid areas cover less than 10% of the Medicare oxygen market.

I will now turn the call over to Ali Bauerlein to cover our financial performance and guidance. Ali?

Thanks, Scott and good afternoon, everyone. During my prepared remarks, I will review the details of the first quarter financial performance and then I will review our guidance for 2016. As Ray noted, total revenue for the first quarter of 2016 was $43 million, representing 27.4% growth over the first quarter of 2015.

Looking at each of our revenue streams and turning first to our sales revenue, total sales revenue was $32.8 million, reflecting 42.4% growth over the same quarter of the prior year and representing 76.3% of total revenue. Total units sold increased to 17,000 in the first quarter of 2016, up 54.5% from the first quarter of 2015.

Domestic business to business sales were $9.5 million in the first-quarter of 2016, and it was our fastest growing channel in the quarter, up 61.2% over the same period in the prior year, primarily due to increasing private label demand for our portable oxygen concentrators. In addition, reseller and traditional home medical equipment provider sales contributed to the growth in the first quarter of 2016 versus the same period in the prior year.

International business-to-business sales were $10 million, representing 18.7% growth versus the same period in the prior year, primarily due to continued strong demand from our European partners. Business-to-business average selling prices in the first-quarter of 2016 declined over the same period in the prior year, primarily due to an increased mix toward private label sales and additional discounts associated with the increased sales volumes worldwide. Direct-to-consumer sales for the first quarter of 2016 were $13.4 million, representing 52.4% growth over the first quarter of 2016, primarily due to the increased inside sales headcount and increased marketing spend to drive consumer awareness.

Now turning to rental revenue. Direct to consumer rental revenue in the first-quarter was $10.2 million, representing a decline of 4.9% over the same period in the prior year, primarily due to the anticipated Medicare rental reimbursement cuts that took effect in the first-quarter of 2016 and higher rental revenue adjustments. Rental revenue represented 23.7% of total revenue in the first quarter of 2016 versus 31.7% in the first quarter of 2015.

We continue to shift sales focus towards consumer sales towards rentals, primarily due to the reductions of Medicare reimbursement [freight] in 2016. At the end of the first quarter of 2016 we had 33,200 rental patients on service, a 10.7% increase over the number of patients on service as of March 31, 2015 and at 1.2% increase over the number of patients on service as of December 31, 2015.

Turning to gross margin, for the first quarter of 2016 total gross margin was 49.5% compared to 47.5% in the first quarter of 2015, up approximately 200 basis points. Our sales gross margin was 49.7% in the first quarter of 2016 versus 45.4% in the first quarter of 2015. The improvement in sales gross margin percentage was primarily related to lower cost of goods sold per unit due to lower materials and labor costs associated with the upgraded Inogen One G3 product launch in the fourth-quarter of 2015.

In addition, an increase in sales mix towards higher margin direct to consumer sales which accounted for 40.7% of total sales revenue in the first-quarter of 2016 versus 38.1% in the first quarter of 2015 improved total sales gross margin. 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 48.9% in the first quarter of 2016 versus 52% in the first quarter of 2015. The main driver of the lower revenue per rental patient was that reimbursement reductions in the first quarter of 2016 and the higher rental revenue adjustment. This is partially offset by lower cost of rental revenues mainly associated with lower depreciation and servicing cost per patient.

As for operating expenses, we continue to make strategic investments in additional sales force headcount and support personnel as well as in the development of the Inogen One G4. As a result, total operating expense increased to $18 million in the first-quarter of 2016 versus $13.5 million in the first-quarter of 2015.

Operating expense as a percent of total revenue was 41.9% in the first quarter of 2016 compared to 40% in the first quarter of 2015. Operating expense included a litigation settlement accrual of $1 million associated with a wage and hour claim. Non-GAAP operating expense excluding this litigation settlement accrual was $17 million compared to $12.6 million in the first-quarter of 2015 excluding the $0.9 million cost for the audit committee investigation.

Research and development expense was $1.2 million in the first-quarter of 2016 versus $0.9 million in the first-quarter of 2015. The first increase was primarily associated with additional personnel and engineering product development expenses mainly related to the Inogen One G4 development.

Total SG&A expenses increased 33.2% to $16.8 million in the first quarter of 2016 versus $12.6 million in the same 2015 period primarily due to the additional investments made in sales and support staff that we expect will facilitate our growth in 2016 and beyond. Excluding the litigation settlement cost incurred in the first-quarter of 2016 and the audit committee investigation cost incurred in the first-quarter of 2015, SG&A expenses increased 35.2% in the first quarter of 2016 compared to the same period in the previous year.

Sales and marketing expense was $9 million for the first quarter of 2016 versus $6.9 million in the same 2015 period primarily due to increased direct to consumer sales force additions and increased media expenses. General and administrative expense was $7.9 million for the first quarter of 2016 compared to $5.7 million in the same 2015 period.

The increase outside of the settlement costs was primarily due to increased personnel related expenses and increased bad debt expense. These increases were partially offset by lower legal and accounting fees primarily due to the audit committee investigation expense of $0.9 million in the first-quarter of 2015.

In the first quarter of 2016, our effective tax rate was 30.4% compared to 35% in the first quarter of 2015 primarily associated with the decreased valuation allowance on net operating losses. In the first quarter of 2016, our effective tax rate before discrete items was 37.4% compared to 38.6% in the first quarter of 2015. The decrease was mostly associated with lower stock compensation dispositions as a percentage of pretax income partially offset by a reduction in domestic production activity deduction received in the first quarter of 2015.

Our net income in the first-quarter of 2016 was $2.4 million compared to $1.6 million in the first-quarter of 2015, an increase of 50.4% in the comparative period and representing a return on revenue of 5.5%. Earnings per diluted common share was $0.11 in the first-quarter of 2016 versus $0.08 in the first-quarter of 2015, an increase of 37.5%.

Moving to our balance sheet, cash, cash equivalents and short-term investments were $86.1 million as of March 31, 2016, an increase of $3.2 million compared to $82.9 million from December 31, 2015. As of the end of the first quarter of 2016, we have no bank debt outstanding and our entire $15 million credit facility was available. In addition, I would like to cover some non-GAAP financial measures.

Adjusted EBITDA for the first quarter of 2016 was a $8.1 million which was an 18.9% return on revenue. Adjusted EBITDA increased 27.3% in the first quarter of 2016 versus the first quarter of 2015 where adjusted EBITDA was $6.4 million.

Since there were no one-time tax adjustments in either period, adjusted net income in the first quarter of 2016 and the first quarter of 2015 were the same as net income. Adjusted net income in the first-quarter of 2016 increased 50.4% to $2.4 million from $1.6 million in the first-quarter of 2015.

Turning to guidance. We are confirming our guidance for the full year 2016. We expect total revenue of $187 million to $191 million, representing 17.6% to 20.1% growth over the 2015 revenue of $159 million.

We continue to expect total revenue headwinds from Medicare competitive bidding national rollout of 3.5% to 4% in full-year 2016. While we do not provide quarterly guidance, we should note that we've historically experienced a seasonally slower first quarter and fourth quarter with higher second quarter and third quarter resulting from the warmer months and when patients are more likely to travel. 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 to become effective in the second half of this year, we could see changes in the seasonality of revenues in 2016. We continue to 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're 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 of rollout of the Inogen One G3 upgrade and the Inogen One G4 product and continued operating expense discipline. We expect these factors will mostly offset the reimbursement declines expected in the Medicare market on an adjusted EBITDA 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 35% or less compared to 32% in 2015, excluding the nonrecurring tax benefit of $1.6 million that is 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 expected to have a smaller percentage impact on the 2016 effective tax rate than it did in the 2015 effective tax rate. In addition, we continue to expect net positive cash flow for 2016 with no additional equity capital required to meet our current operating plan.

With that, Ray, Scott and I will be happy to take your questions.

(Operator Instructions)

Mike Weinstein JPMorgan

This is Robbie Marcus in for Mike. Congrats on the good quarter. Just wanted to start out. It looks like your DTC sales continue to do well, came in above what we were expecting. Maybe you can help us understand how much is the benefit from the bolus of reps you hired in the third quarter coming up to speed now. How much is more critical mass in the market?

How much is your marketing campaign? Maybe give us a flavor for what is driving the continued growth here and how we should be thinking about that through the rest of the year?

Sure Robbie, this is Scott. I will take that one. The majority of the increase that we saw in the first quarter is driven by the rep increase in the second half of last year. In particular, what you see in the first-quarter is really driven by the third-quarter reps because as you recall, it takes four to six months for a rep really to come up to speed. What we are seeing now is really reaping the seeds that were planted in the third quarter.

Now in addition to that, there are some productivity improvements. We make productivity improvements on an ongoing basis, but if I had to scale it, I would say the vast majority of the increase is due to the increased sales capacity.

When you look at increased media, we scale our media right along with our sales reps. We don't want to overspend our sales reps, then you have a bunch of leads that are useless and you don't want to under spend and starve them. As we scale that sales team, we scale the media right along with it.

If you go back to the penetration of POCs in the market, we're still well below a 10% penetration rate POCs versus all of the install base. So there continues to be plenty of headroom for expansion and that's why we continue to scale the team.

And so you added 37 reps last year. Should we see something similar to that this year if you are seeing such continued benefit from adding reps?

We plan to continue to add reps throughout the year. The exact number really depends on our ability to find the right reps that fit within our culture and they have the right skill set. We don't have a specific number on it, but it is in our plan to continue to scale reps throughout the year and we did so in the first quarter.

Okay, and then one last one for me. Gross margin did, I looked back through all our numbers, it looks like this was your best sales gross margin ever. Correct me if I am wrong. We are coming up with double-digit per unit cogs declines in fourth quarter and even more meaningful in the first quarter this year. Somewhere around 15% this quarter and that's only with the G3 refresh. What should we be thinking about for the balance of the year once the G4 comes out, and how far can you take this?

Just to get some numbers straight. If you look at our total cost in divide that by the units sold, a year-over-year comparison would say it's about 15% down and about 6.5% sequential decline from the fourth quarter. So we do see that being a great result and really the driver of the improvement of the sales gross margin with the smaller impact being the slight shift towards direct consumer sales mix versus the business to business side.

So we continue to expect that G3 product as it comes into our fleet in the first quarter. That has come across all of our sales channels. So unlike the G4 where there is a slower ramp, with the upgraded products since people were already using the G3, you sell that impact pretty much for the full first quarter. So when you look forward we do expect to continue to see some decreases in cost to goods sold associated with the G4 launch, but it is a smaller step from what we saw with the upgrade to the G3.

Okay. Great. Thanks a lot.

Margaret Kaczor, William Blair

Good afternoon guys, can you hear me (inaudible).

Margaret, you are breaking up. We cannot hear what you are saying.

Let me know this is a little bit better.

It's a bit better, yes.

On the domestic B2B side, I don't know if you guys can provide the split between how much the growth was between the private labeler sales and some of the online resellers. But maybe tell us a little bit about how those online reseller growth is going and how that growth should or should not accelerate with the G4 launch in the second half of this year?

I'll take some of the numbers first and maybe Scott can also jump in here. But if you look at the business-to-business domestic sales channel, private label sales was the majority of the increase year over year in the first quarter of 2016. So it continues to be a strong contributor to the overall growth in that channel, but resellers are still the majority of sales in that specific revenue channel. So resellers are still very critical to our overall success in that channel, and there will be a rollout of sales into that channel.

Initially we will be capacity constrained with the Inogen One G4, we will start with our direct to consumer sales and moving into the third-quarter, we will begin opening that up to resellers in other business to business accounts. We do expect that to have an impact going into the second half of 2016. Scott, anything to add?

Yes, I think you heard from the size and weight of the G4 at 2.8 pounds, this is clearly a product that is designed with patients in mind first. If I look at our sales channels or sales buckets that to that would benefit the most from a G4 which is targeted right at patients would be our own direct to consumer sales team and then the Internet resellers that are primarily selling retail cash sales directly to patients. As we roll that out to them in the third-quarter, we expect they are going to be as excited about that product as we are.

And one of the questions being that the comps get a little bit more difficult in the back half of the year just because the online, the private labeler sales really increase in the second half of 2015. But do you think that that growth on the private labeler side can continue to come in as strongly as it has so far? And then second of all, obviously can the acceleration maybe in some of these online resellers due to the launch of the G4 offset any potential kind of growth, more difficult comps on that.

Yes, it's an interesting dynamic this year because we've got a lot of things in play compared to history. As Ali said, seasonally the second quarter is usually our high watermark and if we look back over several years, we've got a track record that substantiates that. But this year with G4 launching mid-second quarter and we will have it through the full second half of the year, that is a tailwind for us that could change seasonality and actually have higher sales in the second half of the year than traditional. It's an opportunity to see that happen.

With regard to the private label sales, it's still a little early to call out exactly what the growth rate is going to be or if the growth rate is sustainable. In the first-quarter, this is really our first-quarter in 2016 where we've got a valid year over year comp and even so, if you look at the first quarter of 2015, it was at the very beginning of the launch. It's a little early to tell where that's going to go, but we've got a great relationship with these guys and we're thankful for the solid partnership. We have expectations that we can continue to use this as a viable method to reach that HME channel.

On the other side you've got obviously the reimbursement decline in the second half of the year that will hit again in July, so that works against us. We are not going to really know how these things shake out until they happen. We've got some puts and calls, some things that are in our favor and some thing that work against us and we will have to see.

Just to expand on that a bit, the domestic B2B. Clearly seeing greater than 60% growth in the first quarter is not our expectation going into the rest of the year. So we do expect that to come down as we annualize the private label sales, really starting in the second quarter when those sales become more substantial. But we do expect to continue to grow in that channel, but with direct consumer being our lead revenue channel for the remainder of the year.

You beat me to the punch on asking you what's in guidance, I appreciate that.

And then on the gross margin side, just a follow-up on Robbie's question earlier, given the way and the trajectory of what you guys are doing, you had 49.5% gross margin. I know that there's some reimbursement pressure as we go into the second half of the year, but walk me through why this can't be a 50% plus gross margin Company. Or since you guys look at operating margin and adjusted EBITDA for your comp and how you structure the Company, why can't this be, over the next several years, a 15% plus op margin Company or more? Thank you.

Sure, as you know, we don't give specific gross margin guidance, and the reason we don't give specific gross margin guidance is because it really is heavily mix dependent and as we have different contributions from business to business versus direct to consumer, it does have a large impact on our gross margin. And we also know that those reimbursement cuts that are coming incrementally in the second half of 2016 will also be an additional headwind to our overall gross margin strategy.

When we look at the operating expense side, the direct to consumer side of the business also has higher operating expenses associated with it. So the mix of direct to consumer versus business to business also has an impact on that OpEx leverage but clearly helps the overall dollars and is typically net margin accretive when you add those dollars.

We haven't put out a long-term operating margin profile for the Company, but we do expect to continue to be able to show leverage there and incrementally improve that. A lot will also have to do with the growth rate of the Company. As we see opportunities to continue to expand our sales force because we are in the early stages of POC adoption, we feel like that's more important than getting to the optimal OpEx margin percent, because we want to be able to continue to maintain market share leadership.

That 15% target also really depends on the time horizon and how the market shifts between us selling the product to businesses or a mix of the direct to consumer strategy and how that develops. That will have a big impact on that ratio over time. So at this point what is important to us is to continue to stay at the forefront of leading the POC charge and the switch in the industry, not necessarily a specific long-term margin profile.

Great. Thank you.

Danielle Antalffy, Leerink Partners

Thanks so much for taking the question and congratulations on another good quarter. I was wondering if you guys could give a little bit of color on what you're seeing from the DMEs and whether they are starting to pay more attention to POC therapy. Obviously you guys had a very strong domestic B2B quarter. I understand those are largely sounds like from private label, but just wondering if this is getting more on the radar screen of some of the DMEs and are you seeing them push POCs a little bit more than you have historically?

Yes. Thanks, Danielle. The big question is, what is the industry going to do in light of the reimbursement environment that is going to be prevailing starting in July of this year? It would be a logical assumption that the industry is going to accelerate the switch to nondelivery technology and within the nondelivery technology, again, the logical assumption is that the POC is the best and most cost-effective solution for the industry. But these are logical assumptions that would suggest that the adoption would accelerate in light of lower reimbursement, more challenging reimbursement rates. But we don't know what the baseline is.

It is logical to assume that it will pick up. It is very hard to predict to what extent or how fast it would have picked up at the reimbursement rates would be the same as they are today. I hate to give wait and see answers, but unfortunately this is another one I have to say, yes, you would assume that it is going to go a little faster. How fast, we are going to have to wait and see.

Yes, that's totally fair. I guess my follow-up to that then, Ray, would be in an environment in which DMEs might start to push POCs more, that just let's assume that's what happens. I understand that the market is highly underpenetrated and what you'll probably see happen is the market grow pretty significantly. But can you talk a little bit about how Inogen competes in an environment like that that becomes increasingly competitive with the DME?

I will take that one, Danielle. It starts with share leadership and being the market leader. As people look to convert to POCs, logically where would they look first? You are going to look to the leader.

What Company is already established themselves at the front of the line? Which Company is the partner that can help show them the ropes if they want to convert their business? That's a Company that's already running a successful nondelivery business ourselves.

As far as our strategy and how we go to market, it goes back to our private label partner. With them we've got feet on the street that are out in the market that can work with the HME suppliers that if they're interested in converting to POCs and accessing our products, the private-label partner that we have established is the perfect place to start. And of course, we're here to help that private-label partner so that they are our experts out in the field through that transition.

Okay. Thanks so much.

Mike Matson Needham & Company.

I just wanted to ask about, there was a comment in the press release about an increase in provisions for rental adjustments. Can you explain what that is, what that means?

Sure. Yes, so rental revenue, what rental revenue adjustment is, is basically when you bill a claim, there's a certain percent of claims that end up not getting accepted by the carrier and so those come off of rental revenue as an adjustment. On top of that you also have scenarios where a patient passes away and you can't bill for the whole quarter associated with those patients.

We typically see in the first quarter of any year a higher rental revenue adjustment rate, and a portion of that is associated with, in the colder months you typically see a higher death rate of the patient population. You also see a higher rate of patients changing insurance in first quarter as they switch between Medicare and other plans that can lead to write-offs associated with those patients and those periods. We did have higher rental revenue adjustments in the quarter.

Obviously the biggest driver of the change in rental revenues from the sequential quarter was associated with the reimbursement cuts, and that was a significant portion, $800,000 or $900,000 of the decline in rental revenues in the sequential quarters, with the remainder $400,000 to $500,000 being associated with higher rental revenue adjustments in the period.

All right. That's helpful. Just on the G4, I really appreciate the insight into what some of the specs look like, but I was curious just around the battery life, are there any improvements on that area? And seems like you are really leapfrogging the competitors here in terms of anything that is out there. But just wondering if you have any insight into whether or not they are even close to coming out with something on this size and weight range?

Yes, a couple comments on the specs. First of all, thank you for the compliment on the product. We are excited about a step change that is that big.

As you can imagine, it's pretty difficult when you're down under 5 pounds already to make another 2 pound drop and not compromise from a clinical standpoint. It should keep us out in front. Of course, we don't know exactly what other people have under the hood in their development lab, but we are excited about what we have to bring to the party.

We don't know of anything that would be close to what we are launching, and as we have done our comps against all the other products in the space, the G4 has the highest output per pound of any product that's out there, and that actually includes the stationary concentrators as well. It's any home oxygen concentrator, mobile or stationary.

As far as the rest of the suite of specs, we will release those when we have our formal launch before the end of the month and we do the press release. The battery times with different batteries and all that, we'll release at a later date. We don't have all of those right now, but that should be coming shortly.

Okay, thanks. And then Ali, the quarter overall was good in terms of revenue. I mean a lot of upside. The operating margin was a little lower than we had expected. I know you have commented on this in response to some of the earlier questions, but I just want to make sure that I'm understanding where you're coming from on this.

The limited operating leverage that you saw in the quarter, you are making some conscious decisions to invest in the business and grow the sales force and things like that, which may somewhat come at the expense of some margin expansion. But with the hopes that drives more revenue growth, is that -- so you are making an investment decision essentially Am I hearing you correctly?

Yes, that's fair. What I also want to remind you is the first quarter is typically the weakest quarter in terms of operating expense leverage during the year. Because when you look at the conversions, that's typically where we see the lowest conversion of our direct to consumer media into sales.

So that certainly always has an impact in the business where it drives our operating expense leverage, particularly given we had the higher amount of direct to consumer sales in the period. And you have the lowest conversion in that quarter, that does drive higher operating expenses in the period to reach those sales revenues. And then we did have the one time $1 million litigation settlement that's included in operating expenses as an accrual that also impacted our overall expense ratio.

Okay. Thank you.

Matthew O'Brien Piper Jaffray

Just carry on with G4 here. Are you seeing or hearing anecdotally from your sales force, I know you had really good ECC performance and B2B performance domestically, but are you seeing or hearing it slow down in purchasing among your customers as they are anticipating the launch of that product? Or are you telling us you're already seeing that here in Q2 as basically halfway through the quarter? And that could be somewhat of a little bit of a headwind (inaudible) Q2 and then really start to see the tailwind in the second half of the year?

No, there is no discernible slow down in current sales associated with G4. We have actually been pretty careful to keep the specs to ourselves and in fact, in this call today, it's the first time that we have publicly announced anything about the G4 from a specs standpoint beyond it being smaller than G3 and less expensive to manufacture.

So at the same time we are communicating this to you folks, we're in the process of training our sales force. We keep them just as much in the dark as we do everybody else so that they can focus on selling the product that's available to them today. But we are starting to ramp up those training activities so we can launch G4 before the end of the month.

Okay fair enough. Also in the press release I think it was mentioned that you had seen an increase in sales concessions, can you just talk a little about what exactly is going on in there?

Can you say that again?

I think in the press release you mentioned and increase, I think it was B2B, maybe international, you'd seen an increase in sales concessions and what's the reason for that increase?

Yes, so we have seen, on the international side, price concessions associated with higher volume worldwide. So as our key accounts and key customers have bought in higher volumes, we have given additional price discounts associated with that incremental volume. And so that's (multiple speakers).

Traditional, more volume, lower pricing kind of dynamic. Got it.

Absolutely.

Okay, and then Ali, one more question for you real quick. The AR and inventory levels spiked pretty dramatically in Q1 on a sequential basis, why was that?

Yes, so AR, that's very typical in the first quarter, again, to see the trend of accounts receivable increasing. If you recall, there is an annual deductible associated with the Medicare business and most private insurance is as well and a so that typically delays cash collection in the first quarter. We also had an increase in AR associated with our business to business sales, so those were the two drivers of the accounts receivable increase.

On the inventory side, as we are both ramping up the Inogen One G3 upgrade which did include some new materials, as well as preparing ourselves for the launch of the Inogen One G4, those both contributed to the higher inventory levels as you have new product launches that is pretty typical.

Okay, but no major changes on the AR side in terms of term drop (inaudible) customers?

No. Nothing material.

Got it. Thanks.

This concludes our question-and-answer session and the conference is now concluded. Thank you for attending today's presentation. You may now disconnect.