Business context and reporting period
Inogen, Inc. develops, manufactures and markets portable oxygen concentrators and related products, and sells or rents them through direct-to-consumer and business-to-business channels. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2018; comparisons are with the corresponding 2017 periods. Dollar amounts below are in millions unless noted.
Financial performance and liquidity
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Total revenue | $95.3 | $69.0 | $271.6 | $185.7 |
| Sales revenue | $89.7 | $63.1 | $255.3 | $167.1 |
| Rental revenue | $5.6 | $5.9 | $16.3 | $18.5 |
| Gross profit | $48.8 | $33.2 | $135.0 | $90.5 |
| Gross margin | 51.2% | 48.1% | 49.7% | 48.7% |
| Operating income | $10.4 | $8.3 | $33.1 | $22.4 |
| Net income | $16.4 | $7.3 | $41.8 | $21.6 |
| Diluted EPS | $0.73 | $0.33 | $1.86 | $0.99 |
| Adjusted EBITDA (non-GAAP) | $16.3 | $14.1 | $50.8 | $39.3 |
Sales revenue rose 42% in Q3 and 53% for the nine-month period, driven by higher system volumes: approximately 52,400 units in Q3 versus 36,000, and 152,500 year to date versus 94,000. Rental revenue fell 5% in Q3 and 12% year to date, primarily as the rental patient base declined 13% year over year. Q3 sales gross margin improved to 52.3% from 50.3%; year-to-date sales gross margin edged down to 51.1% from 51.4%. The overall year-to-date gross margin increased to 49.7%.
Operating cash flow was $47.6 million for the nine months, roughly flat with $47.5 million in 2017. Investing activities used $27.0 million, including net purchases of marketable securities and capital spending; financing activities provided $12.2 million, largely from employee stock programs. Cash and cash equivalents were $176.3 million and marketable securities were $47.6 million at September 30. Net working capital was $253.4 million. The balance sheet reports no debt. Total liabilities were $65.8 million and stockholders’ equity was $291.3 million.
Material changes versus the prior comparable period
- Growth came primarily from domestic direct-to-consumer sales and business-to-business sales. Q3 domestic direct-to-consumer sales increased 66%; international business-to-business sales increased 23%.
- Sales and marketing expense more than doubled in Q3 to $26.3 million and rose 89% year to date to $67.4 million, reflecting expanded sales headcount, commissions and advertising. Year-to-date media and advertising expense was $19.9 million versus $8.2 million.
- Q3 net income included a $5.1 million income tax benefit, compared with $1.5 million of tax expense a year earlier. Management attributed the change mainly to stock-based compensation tax benefits and the Tax Cuts and Jobs Act. For the nine months, the tax benefit was $7.2 million versus $2.3 million of expense; excess stock-compensation tax benefits reduced tax expense by $15.2 million.
- Inventory increased to $30.6 million from $18.8 million at year-end 2017. The company also reported a $13.2 million gross receivable from one business-to-business customer, with credit insurance coverage of up to $18.0 million, subject to stated terms.
Outlook, risks and unusual items
- Management expected 2018 rental revenue to decline about 10% from 2017, primarily due to the strategic focus on sales and fewer rental patients, and expected a modest rental revenue increase in 2019. It stated that cash, securities and expected operating cash generation should fund operating and investing needs for at least 12 months.
- Management expected to launch the Inogen One G5 in the first half of 2019 and Inogen Connect on G4 systems before year-end 2018, followed by broader channel rollouts. Inogen Capital, a third-party-financed program for HME providers with no recourse to Inogen for customer defaults, was planned for Q4 2018.
- On November 1, 2018, CMS issued a final DMEPOS rule, after quarter-end but before the filing. It provided for open supplier access beginning January 2019 until a new bidding round expected in 2021, with payment rates subject to CPI and budget-neutrality adjustments. Management said the net effect on 2019 Medicare rates remained unclear. The rule extended blended rates for rural and non-contiguous areas through 2020.
- Management estimated U.S. Section 301 tariffs could increase average unit costs by a low-single-digit percentage beginning January 1, 2019. It also cited reimbursement uncertainty, competitive pressures, foreign-exchange exposure, customer concentration, single-source component suppliers and manufacturing capacity as risks.
- The company disclosed an email-account security incident, apparently occurring January 2 to March 14, 2018, involving potentially affected personal information of approximately 30,000 current and former rental customers. It notified customers and regulators and provided assistance; related remediation, legal and other costs were expected.
- Outstanding supplier purchase orders were approximately $61.6 million; minimum operating lease and specified contractual payments totaled $12.0 million. Warranty liabilities were $9.2 million at September 30, 2018. Management did not expect the legal proceedings described to have a material adverse effect, while noting litigation can consume resources.
Important facts for investors to verify
- Whether sales growth and unit volumes persist, and whether substantially higher sales and marketing spending produces sustained profitable growth.
- How CMS’s 2019 payment adjustments affect reimbursement and rental economics, particularly given the 13% decline in rental patients and the 18.1% capped-rental share of patients on service.
- Whether the large customer receivable is collected on time and remains adequately protected by the credit-insurance terms.
- The eventual costs and any regulatory or legal consequences of the customer-data incident.
- Whether tariffs, single-source supply constraints, vendor purchase commitments and planned capacity expansion affect unit costs or the ability to meet demand.
- How much reported earnings growth reflects operating performance versus unusually favorable stock-based compensation tax benefits; review GAAP results alongside the company’s non-GAAP Adjusted EBITDA.