Inogen Inc (INGN) 2018 Q4 法說會逐字稿

Good afternoon, and welcome to the Inogen 2018 Fourth Quarter Financial Results Conference Call and Webcast. (Operator Instructions) Please note this event is being recorded.

I would now like to turn the conference over to Matt Bacso, Investor Relations Manager. 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 fourth quarter of 2018. This earnings release and Inogen's corporate presentation are currently available on the Investor Relations section of the company's website.

As a reminder, the information presented today will include forward-looking statements, including statements about our growth prospects and strategy for 2019 and beyond, market growth estimates and expectations, hiring expectations, and the impact of recent hires on sales results, marketing expectations, international growth, product development and the upcoming launch of the Inogen One G5, expectations regarding the impact of Chinese tariffs and financial guidance for 2019.

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

We have posted historical financial statements in our fourth quarter investor presentation in the Investor Relations section of the company's website. Please refer to these files for more detailed information.

During the call, we will also present certain financial information on a non-GAAP basis. Management believes that non-GAAP financial measures, taken in conjunction with the U.S. GAAP financial measures, provide useful information for both management and investors by excluding certain noncash items and other expenses that are not indicative of Inogen's core operating results. Management uses non-GAAP measures internally to understand, manage and evaluate our business and make operating decisions. Reconciliations between U.S. GAAP and non-GAAP results are presented in tables within our earnings release.

For future periods, we are unable to provide a reconciliation of our non-GAAP guidance to the most directly comparable GAAP measures without unreasonable effort as discussed in more detail in our earnings release.

With that, I'll turn the call over to Inogen's President and CEO, Scott Wilkinson. Scott?

Thanks, Matt. Good afternoon, and thank you for joining our fourth quarter 2018 conference call.

Looking at the fourth quarter of 2018, we generated total revenue of $86.5 million, reflecting a robust 35.7% growth rate and solid results in all 4 revenue channels. Direct-to-consumer sales of $36.8 million in the fourth quarter of 2018 increased 50.4% over the fourth quarter of 2017, primarily due to increased sales representative headcount and associated consumer advertising.

Our direct-to-consumer sales team consisted of 446 inside sales reps as of December 31, 2018, which represented an increase of 183 reps, up approximately 70% over our 2017 year-end total of 263.

Fourth quarter 2018 domestic business-to-business sales increased to $25.4 million. While business-to-business sales continued to grow, primarily due to strong demand by traditional home medical equipment providers and Internet resellers, order activity did slow from one national home care provider in the fourth quarter of 2018.

Aside from this national home care provider, we saw strong demand across our diversified HME customer base.

Specifically, when excluding this national home care provider in the fourth quarter of 2018, domestic business-to-business sales increased at roughly the average rate of the previous 4 domestic business-to-business sales quarters.

As we have always said, it is important to remember that domestic business-to-business sales can be lumpy quarter-to-quarter due to the inherent challenges facing providers from both an infrastructure and financial perspective.

Despite these natural barriers, we continue to believe the conversion to nondelivery technology is in process and will take at least 5 more years to fully realize.

Fourth quarter 2018 international business-to-business sales were very strong at $18.5 million. While we acknowledge the fourth quarter was our easiest comp in 2018, we were very pleased to see robust European demand without the contribution of any meaningful tenders in the quarter.

Fourth quarter 2018 rental revenue increased to $5.8 million, representing growth of 6.7% compared to the fourth quarter of 2017.

In the face of declining net patients on service, this is the first revenue growth quarter for our direct rental business since the fourth quarter of 2015, when we began to shift our focus away from rentals and towards retail cash sales.

Transitioning to the subject of Chinese tariffs. On December 1, 2018, the U.S. and China agreed to postpone any increase in existing or new tariffs until March 1, 2019, as both sides work towards a more amicable trade deal. Specifically, the U.S. refrained from increasing its China import tax from 10% to 25% effective January 1, 2019, on $200 billion of imported Chinese materials and products.

President Trump decided on February 24, 2019, to delay the increase from 10% to 25% effective March 1, 2019. However, no official trade deal has been reached, and no timing was given for how long this additional delay will last.

Given the level of uncertainty around this global issue, our 2019 guidance continues to assume the full impact of these tariffs on applicable Chinese sourced materials.

Included in guidance is an estimated $4 million increase to our cost of goods sold in 2019 for the revenue range listed.

Going forward, we will continue to monitor any new tariff proposals and economic policy changes, and take the necessary steps to protect our financial interests and mitigate our standard material cost risks.

Transitioning to product development. I briefly want to discuss our next-generation portable oxygen concentrator, the Inogen One G5, which we still expect to launch in the first half of 2019.

Similar to the Inogen One G4 launch, we expect to first roll out the G5 through our direct-to-consumer channel, followed by the domestic business-to-business channel and then the international business-to-business channel.

The Inogen One G5 will produce a higher flow rate of oxygen than the G3, with 1,260 milliliters per minute of oxygen through 6 flow settings and will be smaller in size than the G3. We believe the G5 will have the highest oxygen output per pound of weight than any other portable oxygen concentrator currently available in the supplemental oxygen therapy U.S. home care market, a distinction currently held by the Inogen One G4.

We still expect the G5 to obsolete the G3 over the intermediate term. We anticipate the G5 will continue to keep us at the forefront of patient and provider preference in the portable oxygen concentrator market. With user evaluations complete, we are currently preparing for market launch.

Further, I would like to discuss Inogen Connect, our new connectivity platform for the Inogen One G4 and G5 devices. We launched Inogen Connect with the G4 through the direct-to-consumer channel in December 2018, followed by the domestic business-to-business channel for G4 and OxyGo FIT in February 2019.

Inogen Connect is compatible with Apple and Android platforms and includes patient features such as oxygen purity status, battery run time, product support functions, notification alerts and remote software updates.

We believe home oxygen providers will also find features such as remote troubleshooting, equipment health checks and a location tracker will drive operational efficiencies when transitioning away from the oxygen tank delivery model.

Inogen Connect is planned to be included in the Inogen One G5 at launch in the United States.

As many of you know, recently, there have been some questions from certain members of the investment community on the size and growth of the U.S. long-term oxygen therapy markets and the business practices of some of our Internet resellers. Before Ali reviews our financial results, I wanted to address these issues head-on.

I'd like to comment on the 2015 WinterGreen report, which we had previously cited and felt was a reasonable source for long-term oxygen therapy market data and growth rates.

Since the report was issued, a number of changes have occurred in the U.S. long-term oxygen therapy market as a result of competitive bidding, particularly after rates were applied nationally in 2016.

Given the age of the report, the market changes that have occurred following its publication and the recently released Medicare data from October, we have updated our view of the market based on more recent sources.

While there is no updated single source of long-term oxygen therapy market data, we are now basing our current market estimates on data from CMS, the Kaiser Family Foundation, the U.S. Census, the Centers for Disease Control and our own internal data.

While this information requires us to make certain assumptions, which we believe are reasonable, we also believe it provides a more up-to-date view of the U.S. long-term oxygen therapy market.

While Medicare beneficiary data showed a decline in 2017, when taking into account the shift to Medicare advantage, private insurance, retail sales and the expanding cap base, we believe that overall patient growth was in the low single digits in 2017, and we expect that trend to continue for the next few years.

However, there are other major factors that are difficult to quantify, which we believe will help contribute to patient growth opportunities for POCs that exceed the overall long-term oxygen therapy market growth rate.

First, reduced reimbursement rates as a result of competitive bidding, enhanced Medicare coverage and billing requirements and other factors have created access issues and caused the cash pay market, which is not reflected in the Medicare data, to grow substantially for both new and existing patients.

Additionally, the industry is going through a major conversion from tank deliveries to POCs. We believe that the combination of these factors should lead to growth rates for POCs above the overall long-term oxygen therapy market growth rate over the next 5-plus years.

Lastly, we are an accredited home care provider, licensed to provide respiratory products in all 50 states, heavily regulated by Medicare and the FDA and subject to frequent audits to maintain these accreditations and licenses and we take compliance with the law seriously.

Specifically, we have compliance requirements in place for our authorized Internet resellers. And without commenting on any specific Internet resellers, we expect that our Internet resellers abide by all applicable laws and regulations. We believe this is common practice in our industry, as our Internet resellers also sell most competitive POCs in the market today as well as other home care products.

It's also important to note that most Internet resellers are not accredited home care providers and are not enrolled as Medicare suppliers, meaning they cannot and do not bill Medicare.

We sell a variety of Internet resellers -- to a variety of Internet resellers, none of which are material customers. And combined, they represent less than 15% of our total revenue in 2018.

I also want to point out that we received testimonials from our patients regularly, about how our products have changed their lives and allow them greater freedom and independence.

While some patients would rather receive products using their insurance benefits, the reimbursement dynamics in oxygen therapy have led some patients to seek better options, even if it means paying out of pocket. We are proud that we and our customers can make a difference in these patient's lives.

Looking at 2019, we expect to remain a high-growth company and to continue to make the appropriate investments in our sales force, advertising efforts and operations in order to drive portable oxygen concentrator adoption worldwide.

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

Thanks, Scott, and good afternoon, everyone. During my prepared remarks, I will review our fourth quarter of 2018 financial performance, and then provide details on our updated 2019 guidance.

As Scott noted, total revenue for the fourth quarter of 2018 was $86.5 million, representing 35.7% growth over the fourth quarter of 2017.

Looking at each of our revenue streams, and turning first to our sales revenue, total sales revenue of $80.7 million in the fourth quarter of 2018 reflected 38.4% growth over the same quarter of the prior year. Total units sold increased to 46,100 in Q4 2018, up from 35.6% -- up 35.6% from 34,000 in Q4 2017.

Direct-to-consumer sales for the fourth quarter of 2018 were $36.8 million, representing 50.4% growth over the fourth quarter of 2017, primarily due to increased sales representative headcount and increased advertising expenditures.

We are proud of the growth we achieved in the fourth quarter of 2018, given the difficult comparable in the prior year, where direct-to-consumer sales increased essentially. As a reminder, this is normally not the case given seasonality of our business.

Domestic business-to-business sales of $25.4 million in Q4 2018 reflected 16% growth over Q4 2017. When looking at customer mix, we saw strong demand from traditional HME providers and Internet resellers, but were negatively impacted by reduced orders from one national home care provider in the fourth quarter of 2018.

Excluding this national home care provider in the fourth quarter of 2018, domestic business-to-business sales increased at roughly the average rate of the previous 4 domestic business-to-business sales quarters.

International business-to-business sales of $18.5 million in Q4 2018 increased 54.5% from Q4 2017 and was driven mostly by strong European volume. While Q4 was our easiest growth comparable in 2018, demand continues to exceed our expectation despite the absence of any tender activity and the 2.5% headwind from foreign exchange rates.

Sales in Europe represented 87.8% of international sales in the fourth quarter of 2018, up from 84.3% in the fourth quarter of 2017. Sales revenue per unit sold increased over the same period in the prior year by 2%, primarily due to increased mix of direct-to-consumer sales, which have a higher average selling price.

Rental revenue represented 6.7% of total revenue in the fourth quarter of 2018 versus 8.5% in the fourth quarter of 2017. Rental revenue in the fourth quarter of 2018 was $5.8 million compared to $5.4 million in the fourth quarter of 2017, representing growth of 6.7% from the same period in the prior year, primarily due to higher revenue per patient on service due to the non-CBA rate increase that went into effect Q1 of 2018 and lower rental revenue adjustment. This increase was partially offset by a 12.4% decline in net rental patients on service.

Turning to gross margin. For the fourth quarter of 2018, total gross margin was 50.4% compared to 48.2% in the fourth quarter of 2017. Our sales gross margin was 51.4% in the fourth quarter of 2018 versus 50.5% in the fourth quarter of 2017. The sales gross margin increase was primarily due to a favorable mix shift towards higher gross margin direct-to-consumer sales versus business-to-business sales.

The favorable mix was partially offset by lower average selling prices in both the domestic and international business-to-business channels in exchange for increased volume and lower direct-to-consumer pricing effective June 1, 2018.

Average cost of goods sold per unit also increased 0.4% in the fourth quarter of 2018 compared to the fourth quarter of 2017, due to increased direct-to-consumer mix where consumers tend to buy configurations with additional accessories.

Rental gross margin was 36.2% in the fourth quarter of 2018 versus 23.2% in the fourth quarter of 2017. The increase in rental gross margin was primarily due to increased rental revenue for patient on service and lower depreciation expense.

As for operating expense, total operating expense increased to $38.8 million in the fourth quarter of 2018 or 44.8% of revenue versus $25.6 million or 40.1% of revenue in the fourth quarter of 2017, as we invested in sales personnel, infrastructure and related advertising to support planned growth.

Research and development expense increased to $1.7 million in the fourth quarter of 2018 compared to $1.4 million recorded in the fourth quarter of 2017, primarily due to increased personnel-related expenses and product development expenses.

Sales and marketing expense increased to $28.3 million in the fourth quarter of 2018 versus $15.2 million in the comparative period in 2017, primarily due to increased personnel-related expenses as we continue to hire inside sales representatives at our Cleveland facility and increased advertising expenditures.

In terms of sales rep addition cadence, we hired the most new reps in the third quarter of 2018, which increased expenses for these reps in the fourth quarter of 2018, when these reps were not at full productivity, but we believe this is expected to contribute to strong sales in 2019 as these reps reach their productivity target.

In the fourth quarter of 2018, we spent $10.8 million in advertising as compared to $4.4 million in Q4 2017. In the fourth quarter of 2018, we did have higher media-related expenses due to inefficiencies created by the larger increase in sales reps as well as the midterm election cycle and health insurance planned open enrollment.

General and administrative expense decreased to $8.8 million in the fourth quarter of 2018 versus $9 million in the fourth quarter of 2017, primarily due to a $0.5 million reduction in patent defense cost and a $0.4 million reduction in bad debt expense, which was partially offset by increased personnel-related expenses.

Operating income for the fourth quarter of 2018 was $4.8 million, which represented a 5.5% return on revenue. Operating income declined to 8% in the fourth quarter of 2018 versus the fourth quarter of 2017, where operating income was $5.2 million or an 8.1% return on revenue.

The reduction in fourth quarter 2018 operating margin compared to fourth quarter of 2017 was primarily due to significant investments in sales personnel, infrastructure and related advertising.

In the fourth quarter of 2018, we reported an income tax benefit of $4.2 million compared to a $6.4 million income tax expense in the fourth quarter of 2017, which included a $7.6 million noncash income tax provision expense associated with the revaluation of our deferred tax asset.

Our income tax benefit in the fourth quarter of 2018 included a $6 million decrease in provision for income taxes related to excess tax benefits recognized from stock-based compensation compared to $3.5 million decrease in the fourth quarter of 2017.

Excluding both the deferred tax asset revaluation expense and the stock-based compensation benefit, our non-GAAP effective tax rate in the fourth quarter of 2018 was 30.6% versus 40% in the fourth quarter of 2017, primarily due to the impact of U.S. federal tax reform.

In the fourth quarter of 2018, we reported GAAP net income of $10 million compared to a GAAP net loss of $600,000 in the fourth quarter of 2017. Earnings per diluted common share was $0.44 in the fourth quarter of 2018 versus net loss per diluted common share of $0.03 in the fourth quarter of 2017.

Cash, cash equivalents and marketable securities were $240.3 million, an increase of $16.5 million compared to $223.9 million as of September 30, 2018.

Now turning to guidance. We are reiterating our full year 2019 total revenue guidance range of $430 million to $440 million, representing growth of 20.1% to 22.9% versus 2018 full year results.

We still expect direct-to-consumer sales to be our fastest-growing channel and domestic business-to-business sales and international business-to-business sales to have a solid growth rate.

While we continue to see strong demand from traditional HME providers, given reviews to order activities from one large provider, we expect domestic business-to-business sales to grow modestly in the first half of 2019, with growth improving in the back half of 2019 as our revenue period-over-period comps get easier.

Internationally, we still expect we will be primarily focused on the European markets in 2019. Lastly, we continued to expect rental revenue to grow modestly in 2019 compared to 2018, in spite of the additional 3.9% cut to portable oxygen concentrator Medicare reimbursement rates effective January 1, 2019, and the change in accounting associated with the new lease standards that require rental bad debt expense to be a rental revenue adjustment instead of a general and administrative expense.

We are reducing our full year 2019 GAAP net income guidance range to $40 million to $44 million, down from $48 million to $52 million compared to 2018 GAAP net income of $51.8 million. This decrease in net income is due to a decrease in estimated provision for income taxes related to excess tax benefits recognized from stock-based compensation from $12 million to $4 million due to our current stock price and fewer expected option exercises in 2019.

When excluding the benefit from the estimated $4 million decrease in provision for income taxes expected in 2019 from stock-based compensation deductions, we expect the non-GAAP effective tax rate of approximately 24% in 2019.

We are reiterating our full year 2019 operating income guidance range of $46 million to $50 million, representing growth of 21.4% to 32% versus 2018 full year results.

We are also reiterating our full year 2019 adjusted EBITDA guidance range of $67 million to $71 million, representing growth of 9.3% to 15.9% versus 2018's full year results.

We still expect net positive cash flow in 2019, with no additional 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 Robbie Marcus with JPMorgan.

Maybe you could spend a minute on the composition of [channels] in the quarter with DTC doing so well and U.S. B2B slowing down a little for the second quarter. Maybe speak to some of the underlying trends you're seeing in the business in terms of distributors willing to purchase POCs. And if this is actually a benefit for you here as you get the benefit of picking up more of the direct-to-consumer sales?

Robbie. It's Scott, I'll take that one. I'll start with the B2B channel. We mentioned that there's a major customer that they slowed down their purchases. But, if you'll note, we also mentioned that the rest of the HME customers are continuing to buy at a rate that's consistent with the previous 4 quarters that we've seen in that channel. So we've got a nice diversified customer base. The rest of them continue to purchase at a nice growth rate. And we wanted to highlight that because, while our large customer, when they slowed down their purchases, it's hard to ignore the total growth rate, we wanted to give some color and understanding on what's going on in the market. So that's the part 1, and we continue to expect that the market will convert to POCs over the next 5 years, as we said. If you look at how things will shape up though, the customer -- the large customer that slowed their purchases, they bought at a much heavier rate in the fourth quarter of '17 and the first half of '18. And then they started to slow down really in the end of the third quarter and in the fourth quarter last year. And we don't know when that they might pick up. Now I tend to not like to talk about any specific customer individually. We always try to tell our story instead of somebody else's story, so let me kind of frame some of the struggles that happened out there in the market at more of a macro level. You'll note that we've always said that purchases by the HME community are lumpy, and people always want to know why do you think they're Lumpy? Why is your guidance in that channel generally a little more conservative? Well, it's because there's restructure challenges that these HME folks are facing that are very difficult. If you look at the spectrum of providers, the smaller providers, they tend to have more issues with cash flow and access to capital. And so for them, just the money to buy POCs versus buying tanks is a struggle for them. If you go to the other end of the spectrum, to the larger players and specifically, a large national home care provider, they tend to have access to capital, but their restructure exercise is much more daunting. They've built successful businesses by having large efficient delivery infrastructure that gives them economies of scale and efficiencies. And no matter those economies of scale, we've always said that if you don't restructure and tear out those costs out of your business, then you won't reap the benefits of the nondelivery model. So it will be a struggle, and we think we'll continue to see starts and stops here and there for various reasons. We'll continue to say that sales and the purchase patterns can be lumpy, but it doesn't change our long-term view of the market that will go through a conversion, it's going to take some time, that's why we've always said this isn't an overnight or a 1-year process as well. It's a many year process, and we think it's at least 5 years from this point. Now if you look at the overall overriding factor in the market is that patients prefer POCs over tanks, okay? And that's -- I mean, that's really what's driven our business, and nothing has changed there. And they don't prefer POC as any less when somebody's facing a restructure issue or a cash flow issue. And that creates a great opportunity for us. POCs are definitely preferred. And if you look at any data set that you can find, there's a lot more people driving around tanks than using POCs today. So we think the long-term opportunity for us to continue to grow is very solid. Now, I guess let's take that over to our direct-to-consumer side. We've invested heavily last year in building that sales capacity. 10 years ago, we developed this model so that we wouldn't lose access to the market when things like this happen. We really enjoy working with the provider partners. We think we're a great resource and we have common goals on helping patients, but we have put ourselves in a position that we have access to market and access to patients whether they face those issues or not, and we're pretty pleased at the position that we're in, and that wasn't by accident. So I think the investments that we made last year should continue to pay off for us. They should continue to drive high growth this year. As Ali said in her comments, we expect that direct-to-consumer will continue to be our fastest-growing channel. And then Europe's kind of set aside from the U.S.A., it's a different animal with different reimbursement. Nevertheless, it's B2B and it's different reimbursement in every market. We're further away from the customers there. So while we're really excited about the growth that we saw in 2018, we'll continue to be a little bit more conservative on our guidance there. But long-term, patients prefer POCs compared to tanks in Europe just like they do here, it doesn't change. So again, I think we're in a good spot to continue to grow, because we have -- we're not only working in a product preferred area in POCs, but don't forget we also have the product that's the most preferred by the patients, the end user as well.

The next question is from JP McKim with Piper Jaffray.

Scott, I just wanted to ask a question on kind of your investment, consisted of the second quarter of heavy investments. And so from our view, we look at out margins and we say they've been going down, so maybe these investments aren't worth it today, but you've got better internal metrics that you look at. So is there a way that you could frame up to us that these investments that -- you're hiring reps and spending on advertising are paying off? Maybe more kind of lead indicators you can provide for us.

Yes. I'll start, and if Ali has something to add, I'll let her chime in. But remember the underlying issue here, or I should say, opportunity, is that -- and I said it earlier, there's a lot more patients dragging around tanks than carrying POCs. Now if you go back to the most recent data that we have, the Medicare data where we look at the measure of POC penetration, it's still pretty modest. That comes out to 11%. Now the data is 2017, and we've been pretty candid to say that, that doesn't capture patients on the retail side, and the retail side is much more significant now due to the access issues than its been. But even if you added a fair amount of basis points to that, or even more conservative and say we doubled it, 20%. 20% penetration is still quite a ways from full penetration in the market. So we feel very comfortable investing in sales capacity looking at the long-term. And you're absolutely right, I mean, we've made some conscious decisions that we were going to make some investments in 2018. We were going to focus a little less than we have on the past on our bottom line. We certainly didn't plan to go into a loss, but we said we'll titrate and if we could actually hold our net income even or better, then we would be satisfied for that and the tradeoff would be a higher growth rate. And if you look at our growth rates, we accelerated pretty significantly in 2018 versus the previous years, and that's even on a higher base. We think looking at the long-term, that's the right investment to make. And we're absolutely long on ourselves. So while, obviously, as a public company, you've got to manage quarter-to-quarter, we do put an emphasis on the long term and the right strategic moves to keep us in a winning position.

Yes, just to add on to that. I mean, I would say we did consciously make an effort in 2018 to accelerate that growth rate, and we are proud of that result. As Scott said, we went from 2017, our revenue grew 23% and in 2018, it grew 43.6%. So a substantial acceleration in our revenue growth rate. And that costs us about 50 basis points of operating margin. So while it did, we are showing less leverage than we saw in previous periods, we do think that, that was a worthwhile investment. Now when you look at the specific quarters, obviously, there was more leverage in the first half of the year than there is in the back half of 2018. And there were some inefficiencies as we did scale this business so quickly. And there were some learnings there as we increased the advertising spend, we didn't see as much efficiencies there as we had hoped, and we really are focused on that now as a key area that we're looking at in 2019, to improve our overall results, is to look at getting those reps fully up to speed and also making sure we have effective and efficient sources for the lead sources that we need. So that is a focus. Obviously, a part of guidance is to improve operating margin versus our 2018 results. And we, as a management team, are certainly focused on that. And we certainly had some headwinds in Q4 that we don't plan to repeat in 2019.

Okay, that's very helpful. And just a couple -- one more for me here. Just can you comment quickly on the G5 COGS compared to G4 or G3, if you can do that? And then how do you give investors confidence at this large HME is just pausing purchases and they're not just buying from another competitor?

Yes, sure. So I'll take the first one. On the COGS side, we haven't put out an official COGS reduction or anything related to the G5 versus the G3 or the G4. Historically, we have been able to reduce cost as we've launched new products and be able to take in lower part counts, design efficiencies, higher volumes, all of that does lead to lower cost over time. So that would be our plan for the G5 as well. There's always some inefficiencies right out of the gate as you're ramping up manufacturing and you're working through the processes so we would expect that to occur with the G5 as well. So at volume, at scale, we do expect the G5 to be a lower cost profile for us and to help improve margins over time, but we haven't quantified the exact impact. And obviously, we haven't yet launched the product to the market, so we would be pretty cautious in doing that until we're kind of through that initial manufacturing build and plan.

Yes, let me take the second part, on the large customer that you talked about on buying patterns and who they're buying from. While they've slowed very significantly, we do still see orders from them. So they certainly have not ceased ordering from us. And they advised that they were going to slow down. So that wasn't a huge surprise once that was communicated for us. But you have to remember that most of the larger guys out there, whether it's national, or even some of the larger medium players, will, generally, dual or even tri-source, to mitigate risks just like we do that with our suppliers. So were they buying units from somebody else? Well, probably. That they -- most people always do when they have that kind of size, just like we do. But that's why it is so important that we continue to invest in product development, that we continue to improve our products, stay ahead of the competition so that we remain the preferred product that's the best way to be the preferred supplier with any customer out there is to drive that patient preference and give a great value, great preference at a reasonable price.

And the next question comes from Margaret Kaczor with William Blair.

So first off for me, you guys addressed market growth commentary on the front end, but just wanted to follow-up on the market dynamics (inaudible) it's a 4-part question. So part a, can you guys address how you're monitoring the market dynamics with an HME penetration? Part B is, what kind of customer targeting efforts are you and/or your private label partner are making? What kind of investments are you putting in the field? And then, I guess, the third part is, how is this year different from what you're seeing either strategically going out throughout this year relative to the prior year or 2? Is it easier, more difficult? And any example you can provide.

Yes. So I'll take that one, Margaret. It's Scott. Thanks for your question. As far as of the penetration rate, the best data available is still that Medicare data. And unfortunately, there's nothing else that we've seen that's cleaner data, so that's our index that we get once a year. Now we watched all of our other advertising and close rate metrics as part of our D2C channel, as leading indicators on what's going on. You look at buying patterns from customers. I mean, certainly, the customers that we sell directly to, we service, monitor, look at what they're buying is, what they're growing year-over-year, for some reason any given customer is not, you go find out why. You always want to find out if somebody's even or down in a growing market and POCs are certainly a growing market. Are they having an issue? Or have you lost a customer? And you've got to find that out and you have to address it. And we, at times, everybody occasionally loses with the customer so it's not that we've never lost a customer in our lives, but if you want to understand if you did why and what you have to do to get them back. So that's what our direct HME team is doing. Now that's a pretty small and modest team. And we've been pretty conservative as far as making investments there. Our investment has been in our primary go-to-market strategy of direct-to-consumer and we've got that is great partnership with our private label partner. They've got more field reps out there that can call on HMEs than we do, and we think they've done a super job. So we've kind of handed that off to them to drive that, and we've been more of a support vehicle to them. What do you need for health? What does pricing look like? You have to make sure that they are able to offer a competitive price. You can't put them in a position where they can't make any money and they price themselves out of the market. So that's where our efforts go is making sure that they have the support from us, that we've got the support to the direct players that we've kind of got our finger on the pulse of the market and understand what's going on. So far, we're pleased with the conversion. Like I said, outside of, albeit, a large customer finding it necessary to slow down, the numbers that we see in the market and all of our metrics are very positive for growth.

Okay. And then just part 2 of that question was, if you look at this year or the future years relative to the prior year or 2, is it better or is it worse? And then if I'm calculating it correctly, excluding sales into this one larger provider, was that growth in B2B domestic almost 50%?

I'll just take the last part of that first. So yes, if you just look at the domestic B2B for the prior 4 quarters, it was up approximately 50% with the growth rate for those prior periods.

Yes. I mean, Margaret, as I said, it'll -- until there is a return to normalcy, it creates a tougher comp in the B2B channel at least in the first half of the year until we catch up with were they slowed down. So we recognize that. As far as the other part of your question is, more challenges this year versus last year. I think there are some inherent challenges as you get on this path to convert your business as a home care provider. When you start out, there's always some low-hanging fruit that every provider can pick. They can put some POCs on either some highly ambulatory patients that shoot through a lot of tanks, and they actually see some benefit without really reducing any significant infrastructure or they can put some POCs on more remote patients that are a higher cost of delivery and they see some fast results there. But you don't see that forever. Eventually, you have to hunker down in the top task of sorting out your infrastructure. And as people have been buying in a fairly brisk rate over the last couple of years, that will be more of a challenge for them that they've got -- for them to really realize benefit, they've got to get those costs out that are associated with delivery. Now as I've said in the past, I think once you get past that halfway point, once you get -- so you've got more patients that are on a POC than on tanks, that makes it a little bit easier. Literally, you're kind of climbing up one side of a hill, and once you get past the halfway point, I think it gets a little bit easier, but we're certainly not on the backside of the hill yet.

Yes. And just to add on to that, we still feel very confident in our guidance for this year at a range of $430 million to $440 million. When we put that guidance in place in November, we had already seen some volatility with this large national provider, which is why when we initially put out the guidance for 2019 that we said we expected solid business-to-business growth domestically. And we did know already the comps were going to be tough for us in Q1 and Q2 2019, just associated with the buying patterns in 2018. So all of that was factored into guidance, and that's why we are conservative when we look at B2B guidance both domestically and internationally, is because we aren't in control and we know that this industry has significant challenges to convert their businesses and that there will be starts and stops and lumpiness in how that's developed over time. So that was factored into guidance. And obviously, we've made a significant investment in our sales force -- direct-to-consumer sales force in 2018, and that's why we expect that to be our fastest-growing channel going into 2019.

The next question comes from Danielle Antalffy with SVB Leerink.

Just one question on the market commentary, Scott. So I think what you're saying now is the oxygen therapy market, based on more recent data, you think is more low single-digit. POC should grow faster than that. Do you have any update specifically on the TAM? I think in the past, you guys have said total of 2.5 million to 3 million oxygen therapy patients. I mean, is that number still an accurate number, given the way -- the new way you guys are looking at the data?

Yes. It's a good question, Danielle, and there's no change to our TAM estimate of 2.5 million to 3 million patients. So yes. We've looked at it a few different ways. We keep landing in that same area. I will emphasize that we've always said 2.5 million to 3 million, we haven't said 3.0 or anything, it's kind of acknowledgment that it's an estimate, it's probably a tougher estimate now than it used to be because of the movement within the data sources. But I think, the key is it's not 20 million, it's not 500,000. We feel very good about that estimate, no change to that.

Yes. Okay, that's perfect. And then one follow-up question on the home care provider that you saw back off on purchasing recently. Is this something that you expect to -- I'm sorry, if I missed this earlier, but you expect this home care provider to start purchasing again? Or is this potentially a customer that's lost? And how in touch with that customer are you today during this time, where they're not actually -- just trying to get a sense if this is something -- if we could see this customer come back? And how much connection you have behind that?

Yes, and I think -- and again, I tried as much as possible to not talk about somebody else's business plan or what they're going to do individually. So let me say it like this. I don't know when they'll come back. They've got some things that they would have to sort out in order for, I think, the pace to pick up where it used to be. I go back to -- remember, patients want POCs and so if they're -- they can't get it through that provider, they can get it through other providers and they can get it through Inogen. That's -- again, I'm happy we've put ourselves in that position 10 years ago. So that we're not blocked from access to the market when the home care provider channel or a big customer like that has some things that they have to tackle. So we just can't predict when, so I don't want to make a prediction that we just don't have clarity on.

Yes. And just to reiterate, that customer is still buying, just in reduced quantities compared to the prior run rate.

The next question comes from Mike Matson with Needham & Company.

Just wanted to start with the -- some of the market commentary that you made it. I know you just gave Danielle kind of the tailored numbers. But I think I heard one other change in what you're seeing. So it sounds like you're now talking about the market kind of being fully penetrated in sort of a 5-year time frame versus the 7 to 10 years that we used to talk about. Did I hear that correctly? And I guess why do you now think it's 5 years?

Yes. I mean, it's a good question, Mike. We've been saying 7 to 10 years, but we realized we've been saying 7 to 10 years for a couple of years. And we've also said we're already in process of the conversion, so we realized if we continue to say 7 to 10 years, we're kind of just pushing that out, right? So that's why we now said more than 5 years. So I still don't -- I don't think it's going to happen overnight. Again, I'll say it's an estimate. We're seeing some of the challenges that people have. Could it take longer? Yes, it could take longer. Could it go faster? Yes, it could. For us, again, that's why it's so important that we have access to the market ourselves so that we have more control of our own destiny.

Right. And remember, if it does take longer than 5 years, say it does it take 10 years from now, that would mean that the cash -- the retail opportunity would be stronger for a much longer period of time. So we see that still as an opportunity for us to be able to continue to capture market share. And as B2B accelerates, then obviously, the B2B sales would be well above our 2019 guidance range or in whatever period that acceleration happened versus expectations.

Okay, that's helpful. And then just with regard to the first half of '19. I understand you don't give quarterly guidance, but are you coming up against some really tough comps in the first half? So I know you've guided to revenue growth range. I haven't calculated exactly where consensus is, but are you comfortable in that with where The Street is modeling things for the first and second quarters of '19? Is there any kind of qualitative guidance you'd like give us around -- do you expect to be -- I'd imagine you're going to be going slower in the first time than the second half, but...

Yes. So thanks for the question. And we don't give quarterly guidance as you know, but we did make the comments around the particularly tough comps in Q1 and Q2 for a reason. So we do think that those growth rates will be challenging in the first half of the year assuming that the large national provider doesn't go back to the cadence that they were buying previously. But we do feel good about still maintaining a solid growth rate in the domestic B2B channel for the full year that had already taken into account some level of volatility within the quarters. But yes, Q1 and Q2 will be more challenging than Q3 and Q4 in the domestic B2B channel from a comp perspective.

Okay. And then just, finally, can you comment at all on the uptake -- or adoption, I guess, of Inogen Connect? I mean, I know it's on the products that you're selling now, but how much of it's been used? And then second point, I guess, will be just on Inogen Capital, kind of just last quarter, it was rolled out -- or talked about rolling out Inogen Capital, so maybe where you can extend with that? What kind of reception have you seen?

Yes. On Inogen Connect, I'll take that one, and I'll turn the Inogen Capital question over to Ali. We launched -- as we said in the patient channel, late fourth quarter, we've seen a ton of patients hook up. It's really kind of exciting because of that geo tracker, we can look at all the products on the map. Actually -- even though we've only sold devices in the U.S.A, you can see where people are taking trips and product shows up in Europe and other places on the globe. We've probably got a little bit heavier connect rate out of the gate than we expected, and it's been a little easier for people to hook up. We beefed up a little bit on the support side, realizing that seniors tend to struggle with these Bluetooth connection things. That's going pretty well. Now it's not for everybody. There's -- some people have no interest, some people say, maybe later, but it's a pretty exciting. Those that really value it and to see they're moving about in that retail channel. It excites the team and I'll say it really excites our engineers that they can see those patients moving around. On the B2B side, we just launched this month, so we're a couple of weeks in, pretty early, most of the B2B customers are just getting their provider portals set up so that they can monitor the data through their portals. So it's a little early to comment. Just like I said, we're only 2 weeks in, but we can have some more commentary on the next call. Capital?

Yes, so on Inogen Capital. Obviously, we were excited to roll that out in the fourth quarter. We have had customers use that. Remember that this is really targeting the small HME providers. So this is really not meant to be a financing source for the regional or large players as most have access to financing through their own banking relationship. So it's really meant to help those small HME providers and we expect that continue to grow in 2019 as more providers get comfortable with the product offering.

The next question comes from Matthew Blackman with Stifel.

If I could start with a couple of more questions on the provider that decreased ordering activity. First, would you be willing to share what percent of your business that customer represents? And then second, just want to be clear. The second half acceleration you expect in domestic B2B, that's purely comp driven, right? Your guidance doesn't contemplate that provider accelerate its ordering in the back half?

Correct, yes. So let me take the first question. So that customer was not a material customer. That customer actually was purchasing through a private label partner, who is a material customer, so just to make that clear. But our guidance does not assume that, that customer accelerates growth in the back half, and that, that's contributing to the overall guidance number.

Okay. And then if I could shift to cash deployment, and this is for Ali or Scott. I assume M&A is still the highest priority and any updates on business development activities would be helpful. But also just given the volatility in the stock, I'm curious if you're now more actively considering other ways of putting the balance sheet to work?

Yes. Let me talk about the M&A piece first. We continue to look for the right product to add, but we're certainly not at a point where we just want to add something to add it. So the bar continues to be high. We'd like something, obviously, that's disruptive. We don't want to just add a me too product that we sell on price that's really a waste of this fantastic asset that we have in our direct-to-consumer sales force and our marketing team. So we continue to look. Obviously, haven't found anything yet. We haven't closed anything. If we were to get to a point where we feel like we're over that backside of the mountain that I described with Margaret, and we haven't found anything yet, then we'd probably relax our criteria. But right now, we're really looking for something that would be disruptive, big market, leverage all of our expertise and haven't found it yet. And the second part of the question?

Yes, I'll take that. So on other capital allocation strategies, currently, all options are certainly items that we could pursue in the future. Nothing has been decided at this point that would be appropriate given that we still have a large opportunity on the acquisition front, and we expect to use cash at some point in time for that. So no change in capital allocation strategy at this point.

Okay. And if I could sneak in one last one for you, Ali. Just given the large increase in the sales force denominator, is there a way you can give us a 10-year direct productivity rate in 2018? And maybe how that compared to 2017? Anything precise or even directional would be helpful.

Yes. We really don't disclose that for competitive purposes. It's particularly as more of our manufacturing competitors have now jumped into the direct-to-consumer space. We like to keep that information very tightly held in our organization.

But I think in the past, you've said that sort of on a year-to-year basis instead of a low single-digit increase, I'm just wondering if that's still accurate?

Yes, that is still accurate. So we do expect to continue to improve productivity each year. So each year, we have initiatives on the productivity side to improve that. And usually, that's a couple of percentage points. Sometimes the things that jump productivity are things like new product launches, that type of thing but nothing like that is assumed in guidance.

The next question comes through from Matthew Mishan with KeyBanc.

Just a follow-up on the M&A piece of it. Are you guys seeing that type of products in the pipeline that you think could be a good fit for Inogen to leverage the direct-to-consumer channel, but not necessarily at the right price right now? And just curious what do you think really would be the kind of criteria of a product that would leverage your DTC sales force?

Yes. I think it's fair to say we really haven't found the right product, one that is truly disruptive, because if you believe you have the right product, and of course, there's a reasonable limit, but price is not that important if you think you have the right product. It's going to keep you on a high-growth path for many years in the future. So I suppose somebody could price themselves out of the market, but the main thing is that we haven't found the right thing that we think is disruptive that really fits what we want to do from a market standpoint. We've seen some things that -- I'll say they caught our eye. It's not that we don't have anything that we -- we've got some things we have our eye on, but they haven't been compelling enough for us to jump. It's -- I think it's fair to say that if we were a few years out in the future, some of these things that we've said, maybe that checks of 5 of our 6 boxes that we want, we might be willing to take that if we didn't find something compelling in the next couple of years. But right now I'll say we're very picky right now.

Yes. And I would say also of the ideas that we're watching, it is important for that clinical efficacy in making sure that is something that really will make a difference to patients and treat their needs. So that's something we're evaluating all ideas, really taking at the forefront.

We have seen some pretty cool things though, Matt,. I'll say. They were great products but didn't leverage our direct-to-consumer approach. So that's where it wasn't a good match.

And then the last question. Can you give us a sense of what the underlying growth for sales and marketing is in 2019 that's implied by your guidance? I'm just trying to understand the leverage to the direct-to-consumer next year? And how we should think about the phasing of the growth of sales and marketing for 2019?

Yes. So obviously, we don't give specific guidance on the sales and marketing line, just a qualitative basis. So we do expect to see some leverage. The best leverage should happen in Q2 and Q3, just given when we see our normal sales seasonality and then lower in Q4 and Q1. So I would expect that trends to repeat in 2019 as it has in most years, all else being equal. So I do think that, that's important to note. But we do expect to see some efficiency compared to where we were in 2018 because remember, the rate of sales force expansion in 2019 should be lower than the rate for the last couple of years.

This concludes our question-and-answer session. I would like to turn the conference back over to Scott Wilkinson for any closing remarks.

Thanks. I wanted to close by saying 2018 was a year of investment for Inogen, as we continued to scale our sales infrastructure associated with our direct-to-consumer conventional strategy. These investments helped us deliver record revenue and bottom line results in 2018 and helps position Inogen for what we believe will be another year of strong revenue growth in 2019.

We are executing on our strategic initiatives and remain focused on increasing adoption of our best-in-class portable oxygen concentrators. I would likely last to thank our employees for another fantastic year. Thank you, and good evening.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.