Inogen, Inc. — Q2 2015 Form 10-Q
Reporting period: Three and six months ended June 30, 2015; comparisons are with the corresponding 2014 periods. Financial statement amounts are in millions of dollars unless stated otherwise. The interim statements are unaudited.
Business context
Inogen develops, manufactures and sells or rents portable oxygen concentrators. It serves patients directly, including through Medicare and other insurers, and sells through healthcare providers, distributors and resellers. The company reported one business segment.
Financial performance
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Sales revenue | $32.4 | $20.5 | $55.4 | $35.3 |
| Rental revenue | $11.6 | $9.9 | $22.3 | $18.7 |
| Total revenue | $44.0 | $30.4 | $77.8 | $54.0 |
| Gross profit | $20.8 | $15.1 | $36.8 | $27.1 |
| Income from operations | $5.3 | $4.0 | $7.9 | $5.5 |
| Net income | $3.5 | $2.3 | $5.0 | $3.2 |
| Diluted earnings per share | $0.17 | $0.11 | $0.24 | $0.11 |
| Adjusted EBITDA (non-GAAP) | $9.6 | $7.4 | $15.9 | $11.8 |
Total revenue grew 44.9% in Q2 and 44.0% in the first half, driven by higher system sales and a larger rental patient base. Q2 system sales were 16,400 versus 9,200; first-half sales were 27,400 versus 15,500. Rental patients reached 31,600 at June 30, up from 25,100 a year earlier.
Total gross margin declined to 47.3% from 49.7% in Q2 and to 47.4% from 50.1% for the first half. Sales gross margin fell to 44.8% from 47.8% in Q2 and 45.1% from 48.4% in the first half, primarily reflecting a greater business-to-business sales mix and lower average selling prices in that channel. Rental gross margin was 54.1% versus 53.7% in Q2, and 53.1% versus 53.2% for the first half.
Operating expenses increased: Q2 research and development was $1.0 million, sales and marketing $7.6 million, and general and administrative $6.9 million. First-half amounts were $1.8 million, $14.5 million and $12.7 million, respectively. Higher G&A included legal and audit-related costs associated primarily with an audit committee investigation and securities litigation; the company said the investigation and class action lawsuit concluded in Q2.
Cash flow, liquidity and debt
- First-half operating cash flow was $13.8 million, compared with $8.2 million in 2014. Investing cash outflow was $22.0 million, including net purchases of investments and $6.5 million for rental equipment. Financing cash inflow was $3.2 million. Cash and cash equivalents declined $5.0 million to $51.8 million.
- At June 30, cash and cash equivalents were $51.8 million, short-term investments $14.2 million, and working capital $84.4 million. Accounts receivable was $24.8 million, up from $19.3 million at year-end.
- Debt totaled $0.466 million, consisting of patent-related debt. No borrowings were outstanding on the $15 million JPMorgan revolving credit facility; the company reported compliance with its covenants and $15 million of available capacity.
- Management believed cash, available borrowing capacity and expected operating cash flows would fund projected operating and investing needs for at least 12 months. The company noted that this assessment depends on assumptions and actual performance.
Outlook, risks and unusual items
- No formal revenue or earnings guidance is provided. Management expected an upgraded Inogen One G3 by year-end 2015 and the smaller, lighter Inogen One G4 in the first half of 2016; both were expected to cost less to manufacture than the current G3.
- Management estimated that CMS reimbursement changes could reduce 2016 total revenue by approximately 2.5%–3.5%. It estimated that 41% of Medicare markets would be affected and that rates in those areas could fall by an average of 35%–40%. Medicare accounted for 21.0% of first-half total revenue.
- Medicare concentration, competitive bidding and reimbursement changes, complex claims documentation and collection, and exposure to private-payor rate changes are significant business risks. Three suppliers accounted for 21.6%, 17.7% and 9.6% of first-half raw-material purchases; the company also identified single-source components as a supply risk.
- A material weakness remained in controls over review of sales-order documentation supporting direct-to-consumer sales and rentals before revenue recognition. Remediation steps were underway but not fully tested; management concluded disclosure controls and procedures were not effective as of June 30, 2015. Management nevertheless stated the financial statements fairly presented the company’s financial position and results in all material respects.
- The securities class action lawsuits alleging misleading financial statements and control disclosures were voluntarily dismissed, and the case was closed June 29, 2015. Separate patent litigation against Inova Labs remained stayed pending patent reexamination. The company did not expect ordinary-course proceedings to have a material impact.
- Foreign currency losses affected other expense as the company began accepting euros and received VAT refunds in euros. The company reported no material exposure from a hypothetical 10% adverse exchange-rate movement at period-end.
Most important facts for investors to verify
- Whether the revenue-control material weakness is fully remediated and independently tested, and whether any financial reporting or billing adjustments result.
- Actual CMS implementation, bidding outcomes and reimbursement impact compared with management’s estimated 2016 revenue reduction.
- Whether sales growth and rental-patient expansion persist while sales and overall gross margins remain under pressure.
- Cash conversion and receivables quality, including collection trends and rental-revenue adjustments.
- Product launch timing and performance of the upgraded G3 and G4, along with manufacturing cost and supply-chain assumptions.