Inogen Inc (INGN) 2017 Q2 法說會逐字稿

Good afternoon, and welcome to the Inogen 2017 Second Quarter Financial Results Conference Call. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Caroline Corner, Investor Relations. Please go ahead.

Thank you for participating in today's call. Joining me from Inogen is CEO, Scott Wilkinson; and CFO and co-founder, Ali Bauerlein.

Earlier today, Inogen released financial results for the second quarter of 2017. 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 expectations for international sales and anticipated patient preference; market opportunities and increased use of portable oxygen concentrators; our ability to continue revenue growth and our expectations for our business-to-business and direct-to-consumer sales channels; our strategic focus and objectives; hiring expectations; expectations regarding timing of processing of claims associated with the 21st Century Cures Act; estimates of patent defense expenses; expectations regarding our new facility in Europe and its impact on our market penetration in Europe; expectations involving our facility in Cleveland, Ohio, including with respect to timing of hiring expectations for the facility and the effect of our customer support location based in the Eastern Time zone; the expected impact of our new customer relationship management system including with respect to its short-term and long-term impact to productivity and 2017 guidance, including revenue, net income, adjusted net income, adjusted EBITDA, net cash flow, the need for equity financing, effective tax rates, tax benefits and adjustments, expectations for declines in rental revenue in 2017 and the expected cadence of our quarterly revenue for 2017.

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, 2016, and in its other filings with the Securities and Exchange Commission.

Additional information will also be set forth in Inogen's quarterly report on Form 10-Q for the period ended June 30, 2017, 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 information available to us as of today's date, August 3, 2017, 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 the non-GAAP financial measures, taken in conjunction with U.S. GAAP financial measures, provide useful information for both management and investors by excluding certain noncash 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 forecasts and strategic plans, to benchmark Inogen's performance externally against competitors, and for certain compensation decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented in accompanying -- tables accompanying our earnings release, which can be found in the Investor Relations section of our website. For future periods, we have not reconciled our non-GAAP guidance to the most directly comparable U.S. GAAP measures because the timing and amount of material items that impact these measures are inherently unpredictable or out of our control. Accordingly, we cannot provide a quantitative reconciliation of these non-GAAP measures without unreasonable effort.

I'll now turn the call over to Scott Wilkinson. Scott?

Thanks, Caroline. Good afternoon, and thank you for joining our second quarter 2017 conference call.

Looking at the second quarter of 2017, we built on our success, and I'm very proud to say that we saw record total revenues of $64.1 million. This represented 17.5% growth over the same period last year, reflecting great results in our domestic business-to-business and direct-to-consumer sales channels and solid performance in our international business-to-business sales channel.

As we've seen in prior quarters, the expected decline in rental revenue, which represented less than 10% of our revenue in the quarter, was more than offset by the increases in revenue from our sales channels.

In the second quarter of 2017, we delivered net income of $8.3 million and adjusted EBITDA of $14.4 million, which represented 11.3% and 5.6% growth, respectively, over the second quarter of 2016.

We continued to steadily invest in direct-to-consumer sales force additions in the United States. And in international markets, we began to scale sales of our newest product, the Inogen One G4.

We are also working to optimize our new customer relationship management, or CRM system, and I'm pleased that we have delivered such strong sales and solid bottom line results during the second quarter implementation process.

Looking at our revenue streams in more detail, we saw strong demand for our portfolio of innovative auction concentrators across all of our sales channels in the quarter.

We are very pleased with our domestic business-to-business sales in the second quarter of 2017, which increased 32.2% over the second quarter of 2016, exceeding our expectations. Growth here was primarily driven by additional purchases from traditional home medical equipment providers and strong private label demand.

Revenue from our private label partner and traditional HME providers combined, represented more than half of the domestic business-to-business channels total sales revenue in the second quarter of 2017.

We continue to see traditional HME providers turn to portable oxygen concentrators to lower their operating costs in the face of reimbursement reductions, and they are turning to Inogen as the leader in this space.

International business-to-business sales were also solid in the quarter, reflecting 13.9% growth over the same period last year. We are pleased with this result, especially on the heels of a very strong 2016. However, we are mindful that international sales can be lumpy over time due to the timing of tender contracts and business-to-business customer buying patterns.

As you might recall, we acquired our former distributor, MedSupport Systems, in early May 2017 to be our new center of European commercial operations. I'm happy to report that the integration of this organization is proceeding to plan. This acquisition has enabled us to offer multilingual customer service, local repair services and improved distribution, with the goal of deepening our European customer relationships and increasing European market penetration and customer support.

Last quarter, we also received the EC Certificate of European conformity of the Inogen One G4. We believe we are the preferred provider of portable oxygen concentrators in Europe, and we see a large long-term opportunity ahead as the market transitions from tank and liquid oxygen systems to nondelivery solutions.

Direct-to-consumer sales in the second quarter of 2017 increased 33.3% over the second quarter of 2016, also exceeding our expectations. We continued to steadily add new inside sales representatives in the second quarter of 2017, and we are pleased with our sales team's performance. Our strategy is to hire additional sales employees throughout 2017 and invest in marketing activities to increase consumer awareness as we believe this is still our most effective means to drive growth of direct-to-consumer sales.

In June, we signed a lease for our new facility in Cleveland, Ohio. And next week, we expect to start training our first class of direct-to-consumer sales representatives. As we've said before, we are planning on headcount additions of approximately 240 people in the Cleveland area location over the next 3 years.

The facility is expected to provide an ideal area for recruitment across all of northeastern Ohio. We are excited to have a sales and service support location based on the Eastern Time zone, which will allow us to better serve our customers.

As I mentioned briefly, we launched a new CRM system in June, and we are now in the optimization phase of the rollout. We believe this system will help improve productivity of our sales, customer service and billing departments, especially as we look into 2018.

Although our second quarter 2017 sales numbers were strong, we do expect to see a short-term decline in productivity in these departments during the first few months post-implementation, while we invest in training and our employees work through the learning curve in the new system.

I'm really proud of our Inogen associates and our progress this quarter, especially during a time when we acquired an international operation, added a direct-to-consumer-focused facility in the U.S. and rolled out a new customer management system.

While we've been engaged in all of these exciting initiatives to fuel future growth, we've also maintained our current growth momentum, especially in the business-to-business and direct-to-consumer sales channels. And I'm very pleased with the increased penetration we are seeing in these markets, with our best-in-class and patient-preferred products.

With that, I will now turn the call over to Ali. Ali?

Thanks, Scott, and good afternoon, everyone. During my prepared remarks, I will review the details of our second quarter of 2017 financial performance, and then I will review our guidance for 2017.

As Scott noted, total revenue for the second quarter of 2017 was $64.1 million, representing 17.5% growth over the second quarter of 2016.

Looking at each of our revenue streams and turning first to our sales revenue. Total sales revenue of $58 million represented 90.5% of total revenue in the second quarter of 2017, and reflected 27.3% growth over the same quarter of the prior year. Total units sold increased to 32,400 in the second quarter of 2017, up 29.1% from 25,100 in the second quarter of 2016.

Strong domestic business-to-business sales of $21.2 million in the second quarter of 2017 reflected 32.2% growth over the second quarter of 2016, with strong demand from our traditional HME providers and our private label partner.

We also demonstrated solid international business-to-business sales of $14.9 million in Q2 2017. Sales in Europe represented the majority of international sales at 87.6% in the second quarter of 2017, which was down from 92.1% in the second quarter of 2016 due to the sales growth in other international markets.

With strong business-to-business sales again in the second quarter of 2017, average business-to-business selling prices declined over the same period in the prior year, primarily due to the shift in sales towards traditional home medical equipment providers and private label sales and additional discounts associated with the increased sales volumes worldwide.

Direct-to-consumer sales for the second quarter of 2017 were $22 million, representing 33.3% growth over the second quarter of 2016, primarily due to increased sales representative headcount and productivity improvements.

Rental revenue represented 9.5% of total revenue in the second quarter of 2017 versus 16.5% in the second quarter of 2016. We saw the expected decline of rental revenue in the second quarter of 2017 versus the second quarter of 2016, primarily due to the previously discussed reimbursement reductions.

Rental revenue in the second quarter of 2017 was $6.1 million, representing a decline of 32.3% from the same period in the prior year.

Turning to gross margin. For the second quarter of 2017, total gross margin was 49.2% compared to 48% in the second quarter of 2016. We saw an increase in our overall gross margin, primarily due to the lower costs of goods sold and increased mix towards direct-to-consumer sales, partially offset by declining rental gross margin.

Our sales gross margin was 51.8% in the second quarter of 2017 versus 49.4% in the second quarter of 2016. Sales gross margin percentage improved, primarily associated lower cost of goods sold per unit, mostly due to lower materials cost, an increase in mix towards direct-to-consumer sales, partially offset by declining business-to-business average selling prices.

Rental gross margin was 25% in the second quarter of 2017 versus 41% in the second quarter of 2016. The decline in rental gross margin was primarily due to lower net revenue per rental patient, which was mostly driven by the reimbursement rate reduction, and partially offset by lower cost of rental revenue, which was associated with lower depreciation and servicing cost per patient.

As for operating expense, total operating expense increased to $23.1 million in the second quarter of 2017 or 36% of revenue versus $18.2 million or 33.3% of revenue in the second quarter of 2016. Total operating expense increased as a percent of revenue from the comparative period in the prior year, primarily due to the $1 million benefit in the second quarter of 2016 in general and administrative expense for a litigation settlement that did not recur in the second quarter of 2017.

Research and development expense was $1.3 million in the second quarter of 2017 compared to $1.4 million recorded in the second quarter of 2016.

Sales and marketing expense was $11.9 million in the second quarter of 2017 versus $9.6 million in the comparative period in 2016, primarily due to increased sales force personnel-related expenses and increased advertising expense.

General and administrative expense was $9.9 million in the second quarter of 2017 versus $7.2 million in the second quarter of 2016, primarily due to the $1 million litigation settlement benefit recognized in the second quarter of 2016. We also had increased bad debt expense and increased patent defense legal costs in the quarter.

In the second quarter of 2017, our effective tax rate was 9% compared to 6.8% in the second quarter of 2016. We saw a lower-than-expected effective tax rate this quarter due to a $2.5 million decrease and provision for income taxes related to excess tax benefits recognized from stock-based compensation associated with Accounting Standards Update, ASU 2016-09, compared to $2.4 million in the second quarter of 2016.

The decrease in provision for income taxes associated with ASU 2016-09 lowered our effective tax rate by 27.2% in the second quarter of 2017 and by 29.3% in the second quarter of 2016, as compared to the U.S. statutory rate.

Our net income in the second quarter of 2017 was $8.3 million, compared to $7.5 million in the second quarter of 2016, an increase of 11.3% versus the comparative period in the prior year and a return on revenue of 13%.

Earnings per diluted common share were $0.38 in the second quarter of 2017 versus $0.36 in the second quarter of 2016, an increase of 5.6%.

Adjusted EBITDA for the second quarter of 2017 was $14.4 million, which was a 22.4% return on revenue. Adjusted EBITDA increased 5.6% in the second quarter of 2017 versus the second quarter of 2016, where adjusted EBITDA was $13.6 million or 24.9% return on revenue.

Cash, cash equivalents and marketable securities were $144.2 million, an increase of $16 million compared to $128.2 million as of March 31, 2017. We expect Medicare to reprocess claims associated with the 21st Century Cures Act in the third and fourth quarters of 2017, and we received our first payment in July of 2017.

Turning to guidance. We are increasing our 2017 revenue guidance to a range of $239 million to $243 million, which represents year-over-year growth of 17.8% to 19.8%. This compares to our previous guidance of $233 million to $239 million. We now expect direct-to-consumer sales and domestic business-to-business sales channels to be our strongest growing channels and to have similar growth rates in 2017, and international business-to-business sales to have a more modest growth rate in 2017, where the strategy is expected to be focused on the European market.

We expect that rental revenue will decline in 2017 compared to 2016 by approximately 30% based on the lower average rental revenue per patient and a focus on sales versus rentals.

As we've mentioned before, we expect different revenue cadence in the remainder of 2017 from prior years for several reasons. In the direct-to-consumer channel, the factors that we believe will impact this are the effect of hiring fewer new direct-to-consumer reps in the fourth quarter of 2016, the timing of sales [repetitions] expected in 2017 and the expected short-term decline in productivity from our new CRM system implementation.

As HME providers adopt portable oxygen concentrators, this could change our historical sales seasonality in the domestic business-to-business channel as well, which was mostly influenced in the past by consumer buying patterns. Given these changes, we expect our sales to be higher in the second half of 2017 versus the first half of 2017.

We are increasing our guidance range for full year 2017 net income and adjusted net income to $25 million to $27 million, which represents 21.8% to 31.6% year-over-year growth, and compares to previous guidance of $22 million to $24 million.

We estimate that the adoption of ASU 2016-09 will lead to a decrease in provision for income taxes of approximately $8 million in 2017 based on forecasted stock activity, which will lower our effective tax rate compared to our previous expectation of a $6 million decrease.

Excluding this $8 million decrease in provision for income taxes expected in 2017 from stock compensation deductions, we expect an effective tax rate of approximately 36% compared to our previous expectation of 37%. After giving effect to ASU 2016-09, we expect an effective tax rate, including stock compensation deductions, to vary quarter-to-quarter depending on the amount of pretax net income and on the timing and size of stock option exercises.

We are narrowing our guidance range for the full year 2017 adjusted EBITDA to $48 million to $50 million, representing 10.6% to 15.2% growth over 2016 full year adjusted EBITDA. This compares to previous guidance of $46 million to $50 million.

As we outlined before, we expect patent defense legal costs within general and administrative expense to significantly increase in 2017 over 2016 associated with 2 pending lawsuits.

In addition, we are continuing to invest in our new Cleveland facility, European facility and our CRM system in 2017. We are confirming our expectation for net positive cash flow for 2017, with no additional equity capital required to meet our current operating plan.

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

(Operator Instructions) Our first question comes from Margaret Kaczor with William Blair.

First for me, as we look at the B2B domestic category, Ali, I think you mentioned this both this quarter and then last quarter, which is that the second half of the year might be stronger than the second quarter. Were you, a, referring to the B2B domestic in that scenario? And if that's the case, how should we think about seasonality for the second half of the year, whether it's revenues, in growth? And could the Cures Act help drive POC adoption as DMEs, maybe become a little bit more flush with capital?

That was quite a few questions. We'll try and tackle that in order. So first on the seasonality of the domestic B2B. We do think that the seasonality of that business will be -- will change this year, and that really is based on the expectation that as we have additional providers adopting the product, that they will be buying more based on converting their business model or trialing more locations of POCs in their businesses and not tied as closely to consumer buying patterns, which has typically driven providers, both the resellers and the traditional HMEs, to buy POCs in the past based on the consumers demanding the product. And that seasonality, that underlying seasonality, has always been stronger in the warmer months when patients go and want to go travel. So we do expect to have different seasonality on the domestic business-to-business side, although Q2 is a very strong quarter for us, and that was a great increase that we saw in that channel year-over-year. In terms of the Cures Act, and that driving additional adoption, at this point, the Cures Act payment, for us at least, no payments were received until July. And at this point, I would call this a trickle of payments. We have continued to now consistently receive daily payments on this, but I would say the payment level has only been about 10% of the total amount that we expect to receive over the next 6 months. So because of that, I don't think that it's having an immediate impact on the providers, although it seems like the provider community is also experiencing a little bit of influx of cash associated with this. So I think it will really be down to what -- how much cash they get, how quickly, and what they decide -- how they decide to deploy their capital. So certainly it can be an incremental benefit to them, but it all depends on the timing of when that cash comes in and how significant it is for them. Remember, some providers are in specific locations. So they may not even have any Cures Act payments. It just depends on whether they had patients in the rural communities.

Got it. And then in terms of your guidance for the year, I think in the press release, at least, you mentioned that the B2B domestic segment should grow as fast as DTC. [Historically], even maybe a little bit more conservative for that segment, given -- I think you've cited the lack of visibility in the channel. So maybe give us a sense of what changed, to give you guys a little bit more comfort. Is it, in fact, just better visibility? Is it DME purchases? Or are you really seeing clearer signs that the market shifting to POCs?

Margaret, this is Scott, I'll start with that one, and if Ali has something to add, then she can chime in. But we've said in the past that we needed a little bit more of -- what I'll call time in pickle barrel, or time under our belt to really see if there's a conversion in process or not. Now we're about 1 year, 1.5 years down the road from when I made those initial statements. So a lot of it is just the sustained success that we've had in the B2B channel over time. And clearly, the market is moving that way. So I think we're at a point where we're saying, yes, it looks like we're on our way to a conversion. That is what we expected, so that's not really what I would call a surprise or an epiphany. And while I say that, I would caution you that, it doesn't change our view that this is still going to take 7 to 10 years for the market to convert. But I think we are on our way, and we feel comfortable saying that, given the success that we've had not just this quarter, but when you string that success of several quarters, sustained quarters of B2B growth together, there's some substance to that.

Got it. And then I'll sneak one more in, and I'd go back in the queue. But as you look at Cleveland and you mentioned that you're going to train your first class. Can you give us any sense in terms of either size of the class, relative to what you've done historically, because the facility is going to be quite large? But also, just the quality of the candidates that you've gotten?

Yes. As far as numbers go, I mean, we generally don't talk about the numbers on the sales team until we do the end of the year true-up of kind of where we are. But our goal, as it has been, is to continue to hire in as linear a fashion as we can. I would say through the interview process, we are very excited about the quality of the candidates that we interviewed. But we kind of expected that as well. So that wasn't a surprise. It kind of confirmed our expectations. But we'll be in a position to continue to hire on a steady basis throughout the rest of this year and going forward. This gives us the space that we needed to continue that. I think I've said in the past, we're getting pretty tight in our Texas facility. In fact, we're almost full there. So the growth, the incremental net growth in our reps will really take place in Cleveland. And in our other 2 facilities, we'll keep the seats full if we ever have an open seat, because somebody takes off for whatever reason, we'll refill it, but the growth primarily will be in Cleveland going forward.

Our next question is from Robbie Marcus with JPMorgan.

Maybe I can turn back to the guidance again. But by my math, rentals are down 30% for the year, modest international growth. Maybe you can talk us through the scenarios to get to the low end of your guidance range or the high end of the guidance range, and what that implies? Because at first glance, it looks like it's still a fairly conservative outlook, given the recent trends we've been seeing at DTC and U.S. B2B?

I certainly think that consistent with our previous guidance methodology, the closer we are to the end consumer, the more confident we feel in that guidance. And the farther we are from the end consumer in the business-to-business side, both the international business as well as domestically, we tend to look at guidance more cautiously, because those -- that level of growth is not always in our control. And while we are -- we did increase guidance primarily associated with the beat on domestic business-to-business sales, we do really continue to want to be cautious in making sure we don't get out ahead of our customers' demand, particularly given that this transition we're working with customers that are having to convert their business models, and that takes time and cash to make that happen. And so because of that, we still want to be cautious in what we're expecting. But we are more optimistic than we have in the past, just because of the success that we've seen on the business-to-business side. Now direct-to-consumer sales, obviously, as we're closer to the end consumer there, we have better visibility. The variability really is how many heads do we hire and what's the productivity, both the productivity of the CRM system as well as the ramp of the new hires. So those are the real drivers there. Outside of that, it's relatively formulaic in terms of growth. But domestic B2B is still an area that we want to be cautious in our guidance. So we still do see potential upside. If the market continues to convert at a high rate, obviously, what we've been able to accomplish this year already has been a strong indication of that. But assuming that's going to happen for every quarter through the rest of the year, we are still a little cautious in the guidance numbers.

And on the DTC sales guidance, at the first quarter was that the second half would be stronger than the first half because you were implementing the CRM system in the second quarter. Is that now tempered a bit because of how strong the second quarter came through? Or should we still be thinking about the second half stronger than the first?

No, you still should be thinking about the second half stronger than the first. While the second quarter was great, we implemented the CRM system in late Q2. So the impact of the CRM productivity really doesn't get hit until Q3. Now offsetting that is you have reps coming up the curve, you have the new Cleveland facility and the new reps associated with that. So we feel very good about the second half of the year, particularly the fourth quarter.

And then last from me. I noticed that your ASP in the sales business was only down 1% this quarter, breaking a trend with probably high to high single digit declines. Is that now as you're annualizing the launch of the private label or is that better [FX] in the international? Maybe you could help us out with some color there.

Yes. So while it's down 1% in the year-over-year, looking at Q2 of 2017 versus Q2 of 2016, what you have to take into account is the mix shift towards direct-to-consumer. So in that same comparison, direct-to-consumer increased as a percent of sales revenue, going from 36.2% of sales revenue to 37.8% of sales revenue. And that, obviously, has a higher ASP versus our business-to-business sales. So that's the primary driver of the slowdown in the decline in ASPs. We still did see, what I would consider, the typical trend that we've been seeing of business-to-business average selling prices decline in the second quarter. That trend has continued. What you're talking about is more of a mix question between our different sales category.

Our next question comes from Danielle Antalffy with Leerink Partners.

Ali or Scott, not sure who wants to take this, but I just wanted to talk a little bit about unit growth in the quarter, 29%, which is still very strong, but it is a pretty meaningful step down from the unit growth that we've seen, really since you guys have gone public. I mean, I think the last few quarters have been in the 50% to 60% range. So I just wanted to know what's offsetting that? I mean, Robbie just asked ASP, I assume a more moderate ASP decline is helping that. But my second question there is, is that a leading indicator that concerns you guys at all? Is that something we should be tracking more closely, I assume it can be volatile based on how long patients are on the therapy and things like that, but just wondering if you can comment on that?

Danielle, it's Scott. It really ties back to our focus in the direct-to-consumer channel on a sales approach and putting less emphasis on rentals. So we've tightened that in-take criteria and the number of patients that are coming on board are much less on the rental side than in the past. So that's where the slowdown is. With the reduction in reimbursement, that slowdown doesn't have much of an impact on the P&L. That's why we're still able to sustain and show solid growth on the sales side, even though the units are down a little bit from historical growth rates if you look at just pure units. But it has to do with the focus on sales versus rentals as we were in the past.

And Danielle, if you were talking specifically about the units sold decreasing, that growth rate did slow a bit in the second quarter to 29% versus what we saw 51% or so in the first quarter. And that certainly is tied much more closely to the growth rate on the sales revenue side. The sales revenue grew 27%. So we see those moving in very similar patterns outside of ASP declines, and that was what Robbie was talking about, was that we saw only a 1% decline. And that's been really a question of mix between in the second quarter versus the first quarter, we sold more of our units direct-to-consumer versus business-to-business, and that is something that we have seen historically in the second quarter as consumers tend to buy more in the second quarter versus any other quarter in the year out, given the marketing dynamics of how they respond to advertising in those periods.

Got it. Understood. And then just following up on the B2B business, and Robbie asked the pricing question. But just wondering if you're seeing any shift in competitive detailing on the B2B side. Other manufacturers getting more aggressive on pricing for their products as the HMEs are adopting POCs more aggressively?

Yes. Let me answer that in 2 parts. On the competitive front as far as products go, we haven't seen anything significant or a change in product offering by any of our competitors over the period. But on the second part, as far as, are those competitors aggressive with pricing trying to win share as the B2B channel is looking to grow their base of POCs , yes, it's a competitive market. I think that we're doing a very good job of holding our own. We've said in the past that, as the market leader, I think we're in a good position from a cost standpoint, that's why volume leadership is important, it puts you in a good position from a cost standpoint. We've also got strong brand recognition through 10-plus years of advertising out to the patient as well as the provider community. So while the competition is tough, I think we've done a pretty good job of continuing to grow at what is a faster rate than traditional POC growth is. So it would say that we are defending and even growing our share. So hopefully that answers your question.

Yes, and just to add a little bit on that, one thing that we did in the second quarter to continue to increase our competitive advantage was we added a 5-year warranty for traditional HME providers. And we did that really because we stand by the reliability of our product, and we know how important that is to providers to be able to adopt an on-delivery solution and -- so we felt like we could do that at a reasonable cost to us that would be very attractive to our customers. And that has been received very positively by our customers.

(Operator Instructions) Our next question comes from Mike Matson with Needham.

So I've heard your comments around kind of the second half versus the first half revenue trends, but just wanted to ask specifically about Q3 versus Q4 relative to the second quarter. So it looks like the way The Street's modeling things right now is roughly flat -- well, flat with, I guess, what you guys just reported in the third quarter, and then down by about $2 million into the fourth quarter. Does that seem like The Street's got it correctly there?

Yes, I think it depends on -- it's a channel-by-channel question. So the international factors that we tend to look at starting there is -- the summer months can be challenging just due to European vacations, and that last year, was actually our record quarter in the international bucket, where we saw the highest revenue in the third quarter. So that may be more challenging this year, from a year-over-year comp basis, but remember, international business can be lumpy in and of itself. So that's something that we tend to be more modest in guidance anyway, just to account for the lumpiness of that business. So where that comes from Q3 versus Q4, really depends on how our customer's buying pattern happens. So when you move to the domestic B2B, as we said, we expect that to grow over time. Now again, we're still in the early stages of market penetration. And as customers rollout a POC or an on-delivery type of strategy, again, they can hit credit limits or they can have different things that impact their business that would impact the timing between the quarters. So it's hard for us to say at that level of granularity of what we expect revenues to be Q3 versus Q4, and that's frankly why we give annual guidance. There are a lot of factors that impact that. And direct-to-consumer, historically, we've seen a higher sales in the warmer months and lesser sales in the colder months, because of how patients respond to advertising. We think that underlying trend is still there, it's then just a question of sales capacity, because that's the limit to our growth and the direct-to-consumer side is how much sales capacity we have now. And that's why we said we expect stronger sales in the second half versus the first half because our sales capacity we expect to be at a much higher rate. So I know that didn't really answer your question of how The Street has modeled it, but I also don't want to give a simplistic answer to something that's actually quite complicated and not in our control.

I understand, but I guess just sitting here as of today, looking at the third quarter, given all the moving parts with the CRM and the rep hires, and everything, I mean, there's -- you're not trying to send a signal that we should expect revenues to be down sequentially or anything like that? Or you just don't want to comment on, I guess, maybe is the correct answer. But...

Right. So I mean we expect the sales capacity to increase in the third quarter versus the second quarter on the direct-to-consumer side. That we do feel strongly about just given the investments in Cleveland. Where that shakes out in terms of specifically versus the second quarter will depend on how much sales capacity we add and how quickly we can recover from the small productivity hit that we take with the CRM system. We feel very good about the full year guidance and the statement [fit], both direct-to-consumer and U.S. business-to-business sales should grow very strongly in 2017 versus 2016.

All right. And then you made a comment about an increase in bad debt expense. So I was wondering if you could just elaborate on that a little.

Yes, there was an increase in the second quarter of 2017 in bad debt expense. As you know, that bad debt expense can be a little lumpy over time. If we look at bad debt expense as a percent of revenue in the full year -- or the first 6 months of 2017, it was very similar to the bad debt expense as a percent of revenue in the first 6 months of 2016. But the timing difference between Q1 and Q2 were different this year that caused Q2 to have a higher percent compared to Q2 of last year.

Okay. That makes sense. And then finally, just you mentioned increased legal spending for the patent suits. So that's not a sign that any of these cases are headed to trial or anything like that? I mean, is there any possibility we could see trials there, say, in the next 6 to 12 months?

Yes. That is certainly possible in one of the cases, and that's what we have projected in our net income guidance for 2017.

Do you expect that this year, the trial?

Yes.

This concludes our question-and-answer session as well as today's conference. We thank you for attending today's presentation, and you may now disconnect.