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Inogen Inc (NASDAQ:INGN)
Q2 2019 Earnings Call
Aug 7, 2019, 8:30 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning everyone, and welcome to the Inogen 2019 Second Quarter Financial Results Conference Call. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions]

And at this time, I'd like to turn the conference call over to Mr. Matt Bacso, Investor Relations Manager. Please go ahead.

Matt Bacso -- Investor Relations Manager

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 2019. 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 expectations related to sales, headcount, hiring expectations and strategy, HME strategy and expectations, rental strategy changes and the timing and impact of such changes, expectations for revenue channels, marketing expectations, the rollout of Inogen One G5, expectations regarding the impact of Chinese tariffs, expectations regarding competitive bidding, our expectations on the benefits and market opportunities of the Tidal Assist Ventilator or TAV, the potential of TAV to disrupt the non-invasive ventilator market and expand to treat COPD patients, our expectation on TAV sales, our expectation to integrate TAV technology into our oxygen concentrators, financial guidance for 2019, including the impact of the expected New Aera acquisition and expectations for 2020. 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 maybe required by law. We have posted historical financial statements in our second quarter investor presentation and a separate presentation on the New Aera acquisition 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 US GAAP financial measures provide useful information for both management and investors by excluding certain non-cash 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 US GAAP and non-GAAP results are presented in tables within the 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?

Scott Wilkinson -- President, Chief Executive Officer and Director

Thanks, Matt. Good morning and thank you for joining our second quarter 2019 conference call. Looking at the second quarter of 2019, we generated record total revenue of $101.1 million, which is the first time we have surpassed the $100 million threshold for a quarter and reflects growth of 3.9% over the second quarter of 2018. Direct-to-consumer sales of $43.6 million in the second quarter of 2019 increased 14% over the second quarter of 2018, primarily due to increased sales representative productivity, partially offset by an approximate 17% reduction in sales representative headcount in the comparative period of the prior year.

The level of sales representative attrition was higher than expected in the second quarter as many of the reps that we hired in 2018 were unable to meet our sales targets. Furthermore, while sales representative productivity improvements more than offset the loss in sales headcount in the quarter, it did not meet our expectations. Despite successful early trials where we allocated more leads to top performing representatives when scaled across a larger group, this initiative did not generate the benefit we anticipated given the reduced sales representative headcount and less than expected productivity improvements, we expect to realize headwinds to growth in direct to consumer sales in the third and fourth quarter of 2019. With realized improved productivity, we have restarted our sales capacity expansion efforts with the new sales representatives hired across all three facilities in August 2019.

Going forward, we plan to hire at a more controlled pace than what we did in 2018 and we believe we are making the necessary changes to improve our sales management infrastructure to support sales training and on-boarding. We've also made key changes to management personnel to drive better productivity, lower attrition and improved sales predictability. However, we expect sales representative headcount to be down significantly at year-end 2019, compared to year-end 2018, which is the largest driver of our reduced 2019 revenue expectations.

Given the number of leads we are able to consistently generate on a monthly basis, we believe the market remains underpenetrated, but we need to execute our sales capacity expansion and productivity plans to drive future direct consumer revenue growth. Second quarter of 2019 rental revenue of $5.2 million decreased 1%, compared to the second quarter of 2018, primarily due to a 9.1% decrease of patients on service, partially offset by higher rental revenue per patient.

We had approximately 25,900 patients on service as of the end of the second quarter of 2019. In the second quarter of 2019, we made a modest change to our rental intake criteria and initiated our plans to scale a separate rental team, but we do not expect a meaningful contribution from this team until early 2020. Due to the reduction in sales headcount, we now expect rental revenue to be down modestly in 2019 in spite of changes intended to increased rental revenue, such as the change to the rental intake criteria and establishing a separate rental team.

We expect patients on service to increase in the back half of 2019 from the second quarter of 2019 and we expect both patients on service and rental revenue to increase in 2020. Second quarter 2019 domestic business to business sales of $29.7 million decreased 10% from the second quarter of 2018, primarily due to a decline in sales to a large national provider, who purchase through our private-label partner and secondarily due to a decline in sales to our Internet reseller partners.

The large national provider that we have discussed in our last earnings call, accounted for revenue of $700,000 in the second quarter of 2019, down from $8.3 million in the second quarter of 2018. Sales to our Internet reseller partners were down in the second quarter of 2019 versus the second quarter of 2018, as our reseller partners did not see the typical seasonal increase in orders as seen in previous spring and summer months. Excluding this one national provider and sales to our Internet reseller partners, we continued to see strong demand from traditional HME customers. While HME providers continued to convert and purchase portable oxygen concentrators, we continue to expect that growth will be challenged due to ongoing restructuring efforts, lack of access to available credit and provider capital expenditure constraints. As we have discussed in the past, HME providers have communicated to us that they continue to be subject to capital constraints and certain providers have indicated that they intend to reduce or limit purchases in the future.

Additionally, we believe providers will be more conservative with capital investments in the next year due to pending competitive bidding Round 2021 and the lack of visibility to who will win contracts and changes in reimbursement rates. Even though, we still believe the market is under penetrated, patient demand is strong and we have a market-leading product offering. Given these challenges and uncertainties for our business-to-business customers, we are lowering our growth expectations for HME providers and Internet resellers for the remainder of 2019.

Second quarter 2019 international business-to-business sales were solid at $22.6 million, representing reported growth of 8.7% and 14.7% on a constant currency basis. Underlying European demand trends remained strong, as we remain the preferred provider of POCs for key European accounts. Transitioning to the Inogen One G5, we launched in the direct-to-consumer channel in April 2019 and we believe we have strengthened our technology leadership position with this product.

As a reminder, this product is the smallest, lightest and quietest portable oxygen concentrator on the market today, that producers greater than 1,000 milliliters per minute of oxygen. As communicated on our first quarter call, we expect to rollout the Inogen One G5, to domestic business-to-business channel in the third quarter of 2019 and then to the international business-to-business channel by the end of 2019. pending standard regulatory clearances in each market.

On the topic of competitive bidding Round 2021, as expected, the bidding window opens July 16, 2019. Bids are due by September 18, 2019. We still plan to bid in 129 of 130 regions, but we cannot discuss our bidding strategy publicly. We expect pricing to be announced in the summer of 2020 and contract winners to be announced in the fall of 2020, before contracts go into effect January 1, 2021.

As part of the competitive bidding Round 2021 bid preparation tools, CMS provided 2017 and 2018 traditional fee-for-service Medicare beneficiary accounts for each competitive bidding area by [Indecipherable] In evaluating this data, we can see that penetration rates for POCs are higher in CBAs versus non-CBA areas. In 2017, while the total traditional Medicare penetration rate for POCs in the total US oxygen market was 10.8%, it was 14% in CBAs. While we won't know the total of 2018 penetration rate until the data is published in October 2019, we can see that the traditional fee for service Medicare beneficiary penetration rate for POCs in the total US long-term oxygen therapy market in CBAs was 18.8% compared to 14% in 2017.

POC adoption is continuing to progress but we believe we are still a long way from our estimated full market penetration of 65%. Now I'd like to spend some time discussing the significant announcement today of the signing of the definitive agreement to acquire a New Aera, an innovative developer and manufacturer of portable non-invasive ventilators for people suffering from various chronic lung diseases.

We're very excited to announce our plan to acquire a New Aera and certain assets from a related entity for a cash payment of $70.4 million at closing with potential earn out payments of up to $31.4 million based on future sales performance and certain regulatory clearances. We believe New Aera is an innovator in ventilator nasal interfaces and a natural fit with our current business as it strengthens our position in our core oxygen therapy market, which aligns with our mission to increase freedom and independence for oxygen therapy patients through innovative products and services.

We plan to incorporate the Tidal Assist Ventilator or TAV technology directly into our Inogen One portable oxygen concentrators and make the SideKick TAV product compatible with our Inogen At Home stationary Concentrator to continue to advance patient preference and maintain our technology leadership position in the long-term oxygen therapy market.

New Aera completed a small peer reviewed clinical trial comparing the use of their SideKick TAV product with oxygen to standard oxygen alone for patients with either moderate to very severe COPD or interstitial lung disease. The trial showed these patients were able to exercise longer, with markedly better oxygenation and less dyspnea and leg fatigue on TAV therapy than on oxygen therapy alone.

The trial indicated that 83% of patients responded positively to TAV versus 11% on oxygen alone and showed a 136% mean endurance increase. We believe this will allow us to strengthen our product portfolio in oxygen therapy and allow an additional retail sales opportunity. In addition, we plan to use this technology as a platform to expand our total addressable market into the high growth non-invasive ventilation or NIV market. We estimate NIV to be an addressable US market opportunity of over 400 million in 2019, based on the estimated claims paid for traditional fee for service Medicare beneficiaries, and has grown at over 20% per year since 2016. We believe there is a significant worldwide untreated market opportunity. We also believe the NIV market could undergo disruption, similar to oxygen given the pending reimbursement changes due to the inclusion of this category in competitive bidding Round 2021 and the immobile nature of legacy NIV product offerings.

The monthly Medicare reimbursement rate is significantly higher for NIV products than oxygen therapy at a minimum of $934 a month. Also effective January 1, 2019, a new Medicare HCPCS code has been added to allow billing for a multifunction ventilator that includes ventilation and oxygen. We are targeting to launch a product for this purpose in 2021.

Furthermore, we believe that this technology can be used to help a portion of the over 200 million COPD patients worldwide, who are currently not on oxygen therapy and are willing to pay out of pocket to reduce breathlessness particularly during exercise. This technology represents an attractive new opportunity for us and an adjacent market that would leverage our existing direct-to-consumer expertise.

We plan to sell the existing SideKick TAV product to consumers through out inside direct-to-consumer sales force, and our physician sales force and also to business-to-business customers worldwide. The SideKick TAV is a prescription required non-invasive ventilator designed for select patients with various chronic lung diseases. SideKick TAV's unique design is approximately 4 ounces, and it's compatible with certain oxygen concentrators, oxygen cylinders and wall gas, providing one to five liters per minute of oxygen and can deliver higher flow and pressure versus traditional oxygen therapy. We expect sales of the SideKick TAV product to begin in 2020 and we believe it will be gross margin accretive versus our existing oxygen therapy business.

Looking at 2019, we're reducing full year 2019 total revenue guidance to $370 million to $375 million down from $405 million to $415 million, representing growth of 3.3% to 4.7% versus 2018 full your results, primarily associated with reduced expectations of our direct-to-consumer sales channel. We expect revenue in the third quarter of 2019 to be down compared to the third quarter of 2018, due to headwinds in both the domestic business-to-business and domestic direct-to-consumer channels.

In spite of the expected increase in productivity of our sales representatives, direct-to-consumer sales will be negatively impacted by reduction in sales headcount compared to the same period in the prior year. Given the difficult growth comparisons we face in the domestic business-to-business sales channel, the restructuring challenges of some providers and the decreased Internet reseller purchases, we expect declines on the domestic business-to-business channel in the third quarter of 2019, compared to the third quarter of 2018. We expect international business-to-business sales to have a modest growth rate for the remainder of 2019 compared to 2018, in spite of currency headwinds, with easier comparables in the fourth quarter of 2019, due to lower growth rate seen in the fourth quarter of 2018.

We now expect rental revenue to be down modestly in 2019, in spite of the slight change to intake criteria due to reductions in sales headcount, but we do expect the number of patients on service to begin increasing in the back half of 2019 from the second quarter of 2019. Lastly, the New Aera transaction is not expected to materially contribute to the Inogen's 2019 revenue, but we do expect contributions in 2020. While we are not providing 2020 guidance today, we believe we can execute on our planned return to double digit revenue growth in 2020.

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

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Thanks, Scott, and good morning, everyone. During my prepared remarks, I will review our second quarter of 2019 financial performance and then provide more details on our updated 2019 guidance. As Scott noted, total revenue for the second quarter of 2019 was $101.1 million representing 3.9% growth over the second quarter of 2018.

Turning to gross margin, for the second quarter of 2019, total gross margin was 49.7% compared to 49.8% in the second quarter of 2018. Our sales gross margin was 50.7% in the second quarter of 2019 versus 51.1% in the second quarter of 2018. The sales gross margin decrease was primarily due to lower average selling prices, partially offset by increased sales mix toward higher margin domestic direct-to-consumer sales and lower cost per unit in spite of the Inogen One G5 launch and increased tariffs. Rental gross margin was 30.4% in the second quarter of 2019 versus 27.6% in the second quarter of 2018.

The increase in rental gross margin was primarily due to increased rental revenue per patient on service and lower depreciation expense, partially offset by higher service costs.

As for operating expense, total operating expense increased to $38.1 million in the second quarter of 2019 or 37.7% of revenue, versus $34.4 million, or 35.4% of revenue in the second quarter of 2018.

Research and Development expense decreased to $1.5 million in the second quarter of 2019 compared to $1.8 million reported in the second quarter of 2018, primarily due to decreased personnel related expenses. Sales and marketing expense increased to $27.8 million in the second quarter of 2019 versus $23 million in the comparative period of 2018, primarily due to increased advertising expenditures, partially offset by decreased personnel related expenses. In the second quarter of 2019, we spent $11.6 million in advertising as compared to $6.3 million in Q2 2018.

General and administrative expense decreased to $8.8 million in the second quarter of 2019 versus $9.7 million in the second quarter of 2018, primarily due to decreased personnel related expenses, partially offset by $0.3 million in costs associated with the New Aera transaction.

Operating income for the second quarter of 2019 was $12.1 million, which represented 12% return on revenue compared to operating income of $14 million or 14.4% return on revenue in the second quarter of 2018. The reduction in second quarter 2019 operating margin compared to second quarter of 2018 was primarily due to increased marketing expense. In the second quarter of 2019, we reported net income of $10.2 million, compared to net income of $14.6 million in the second quarter of 2018. Earnings per diluted common share was $0.45 in the second quarter of 2019 versus $0.65 in the second quarter of 2018.

Now turning to guidance, as Scott mentioned, we are reducing full year 2019 total revenue guidance to $370 million to $375 million, down from $405 million to $415 million, representing growth of 3.3% to 4.7% versus 2018 full year results, primarily associated with a reduction in expected direct-to-consumer sales.

We expect $5.2 million in incremental costs associated with the New Aera transaction in 2019 with approximately $2.9 million in intangible amortization expense, $1.5 million in other operating expense, acquisition expenses of approximately $0.8 million, including $0.3 million of expense incurred in the second quarter of 2019.

We are reducing full year 2019 net income guidance to a range of $23 million to $25 million, compared to our previous net income guidance of $36 million to $38 million. This decrease in net income guidance range is primarily due to the estimated reduction in revenue and increased expenses associated with the New Aera transaction, but partially offset by an estimated reduction in other operating expenses.

We expect a GAAP effective tax rate of approximately 25% in 2019. The guidance assumes the tariffs associated with imported Chinese materials and products stay at a rate 25% for the remainder of 2019. On August 1, 2019, President Trump announced new 10% tariffs on up to $300 billion in additional goods imported from China effective September 1, 2019. We are still evaluating the impact of these tariffs on our financial results.

Going forward, we plan to continue to monitor any new tariff proposals and economic policy changes and take the necessary steps to protect our financial interests and reduce our standard material cost risks. We are also reducing full year 2019 operating income guidance range to $26 million to $28 millions inclusive of the New Aera incremental costs, compared to previous operating income range of $42 million to $44 million. And we are also reducing our full year 2019 adjusted EBITDA guidance range to $49 million to $51 million, inclusive of the New Aera, incremental non-amortization costs, down from $66 million to $68 million.

With that Scott and I can take your questions.

Questions and Answers:

Operator

Ladies and gentlemen will begin the question and answer session. [Operator Instructions]. Our first question today comes from Danielle Antalffy from SVB Leerink. Please go ahead with your question.

Danielle Antalffy -- SVB Leerink -- Analyst

Hey, good morning, everyone. Thanks so much for taking the question. Scott and Ali, I just wanted to start with a sort of higher level question. I guess what gives you -- it feels like initially this was an issue in the B2B domestic side of things with the major HME provider slowing purchasing. Now it feels like you're getting hit a little bit on all sides and i guess what -- the first question is what gives you the confidence that it's not something deeper, more underlying in market dynamics? I guess that POC concentration or -- penetration sorry, is increasing but you do have another competitor out there? Is it increasing to the extent that we thought, is there something that has to do with the pricing dynamic and can you give us a little bit of color about what gives you confidence that the underlying growth is still there, number one; number two, that imaging is -- is still in a winning position, because I do know you guys price it at a premium to the competition. So just a little color on your confidence behind the underlying growth here.

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah, thanks, Danielle. It's Scott, I'll take that one. So let's kind of peel back the onion in a couple different areas for a second. First I'll start with direct-to-consumer sales and the market and where we are in the market. So if you look at all the numbers that Medicare provides, whether it's through the recent competitive bidding tools or the penetration rates that we use traditionally tracking the HCPCS code. The market is still way below the full penetration point. We have confidence in that and we also validate that when we look at the number of leads that we can generate every month, it's 10s of 1000s of leads of real oxygen patients that answer our advertising that they're trying to get POCs. So I think when we assess is the market saturated or fully penetrated, those numbers indicate that we still have opportunity, not only now, but into the future, and that's why we're getting back on the horse to expand our sales capacity again, so that we can drive growth in the future.

Now, if you also peel back the onion on the issues with the DTC sales, we've talked about in the last call or so that some of the reps that we hired in 2018, we struggled to get them up the curve, and we continued to work with them to a point where, in the second quarter, a lot of them worked themselves one way or another out of the company. Some of them left of their own accord because they didn't -- they weren't successful, they didn't make the money they expected, because they didn't hit their quotas. In some after trying to work with them, it was clear that they just couldn't do this job successfully, so we proactively transitioned them out.

When you compare that with our other sales reps, and seasoned sales reps and you track their productivity and success, we still see great results with them. So if you had market saturation issues, you'd see a decline in some of those other metrics with the seasoned wraps. So when we peel that back and look at what can we do better, where did we have execution challenges and how are we going to address those, we've put real plans in place as far as improving our hiring intake criteria, looking at better metrics to make sure that we consistently follow processes through the hiring and on-boarding process, we put more infrastructure in place to support those reps as they come up the curve. And we've also, while it's been a small amount, we have had two hiring classes with some of these changes implemented and we've seen great results with those small classes. So two smaller classes, those folks have beaten the historical productivity curves. We have had almost no attrition from those classes, and they're having success. So, when you roll all that up, we have confidence to begin hiring again and expand our sales capacity, but you kind of have to bite-off some of the attrition that we had to swallow, because obviously we didn't execute as well as we have historically and that is going to take a toll on our ability to grow the rest of this year, but long term, we think we're still in a great position for growth. We still are the market leader, we still have the best product -- patient preferred products we talked a little bit in my prepared remarks about the G5 launch, not only have we traditionally had the best product, but we just launched an even better product than what's the best. So we feel very good about the future and our ability to get back on that double digit growth wagon. Now, that's on the B2C side. And if we talk about B2B, the struggles that we've described here and the challenges really aren't any different than what we've talked about in the past, providers have always been undercapitalized, they've always been challenged with cash flow. We've developed some innovative financing programs to help them, but they still have to swallow the restructure hurdle to really make the non-delivery model work. So we acknowledge that's going to continue to be a challenge.

I think competitive bidding kind of hitting them between the eyes, and being right in the middle of the bidding window, has a little bit of a psychological effect on everyone, makes them a little more pessimistic. And then for the smaller players, it's a very real challenge, because there's a chance they could get screened out of the market. So, we expect there'll be a little more conservative going forward until it shakes out, are they in or they out and what are the rates going to be? And these are headwinds that we've dealt with on and off through the past, they're just not going to go away, it's why we've always said despite POCs being compelling from a cost to service standpoint, as well as a patient preference standpoint, that this transition is a process, not an event because of those hurdles.

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

And [Speech Overlap] just add a little -- on their Danielle, I know, you also asked about pricing and competition, we really aren't seeing anything dramatically different in the market in those areas. Pricing, well, our business-to-business customers are always price sensitive. We aren't seeing any new dynamics from a competitive front. So we believe we're continuing to maintain our market leadership position there. And that those are not the dynamics impacting our changes and assumptions going forward.

Danielle Antalffy -- SVB Leerink -- Analyst

Got it. Okay, that's helpful. Thank you guys. And then I know you're not giving 2020 guidance, Scott, you mentioned you thought a double digit growth or return would be doable to double digit growth. I guess, can I ask you these issues that you guys -- headwinds that you're facing seem like, it's hard to predict, how quickly they'll lift and for example, when the major HME provider will start purchasing again. And so I guess what are you looking at there? Is that gives you the confidence? or you having conversations with the large HME provider that makes you think they'll start purchasing again in 2020? Can you give a little bit more color to the drivers of that comment there? Thanks so much, guys.

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah, the large national that we talked about in the past, we don't have them in our growth plans or returning to purchase. So, if they were to do that would be upside. We continue to think that their struggles are more longer term to address their restructuring hurdles. The other home care companies out there, they face some of those similar hurdles. They just haven't decided to stop purchases. They're up and down and you see, one is up, another is down any given quarter, we don't expect and we are in pretty close contact with people. I'll say we try to be in closer contact, given what happened with that large national. Nobody's telling us that they don't see POCs as the future but they do convey their hurdles. So they have to balance that, that they're trying to convert their business, they're trying to serve patient demand. But they have some constraints. So, we'll help them to extend the extent that we can. But what really is important to us and I think, again, what's unique for us with our direct consumer approach is that we can drive more of our own destiny and while to some extent, we're a little dependent on them. I mean, they're a pretty sizable portion of our revenue portfolio, they're not our entire revenue portfolio. So for us, to continue to drive that sales capacity growth, when we model that out in kind of lap, where we are being down in headcount now and projecting where that would be next year, that gives us the confidence to make a statement that we feel we can return to double digit growth in 2020.

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

And just expand a bit on that, Danielle, when we look at our total revenue excluding that national account on a year-to-date basis, we're up 19.6%. So obviously, we are dealing with a comp issue that eases a bit in the back half of this year, and is really, we're through that headwind going into 2020.

So, that's just in and of itself should help the overall growth rate lapping those large sales that we saw in 2018. And with the additional hiring and what we're seeing on the B2C side, we also should be lapping the tougher comps there, and that should help 2020 as well. We also expect as we said, rental revenue to start increasing and not being a headwind to growth going into 2020 as well.

Danielle Antalffy -- SVB Leerink -- Analyst

Thank you so much.

Operator

Our next question comes from Margaret Kaczor from William Blair. Please go ahead with your question. Ma'am, is it possible your line is on mute?

Margaret Kaczor -- William Blair -- Analyst

Yup. Can you guys hear me?

Scott Wilkinson -- President, Chief Executive Officer and Director

Yes.

Margaret Kaczor -- William Blair -- Analyst

Perfect. Sorry about that. And good morning, and thanks for taking the questions. At first off, I was hoping to maybe drive a little bit more Danielle's second question, which kind of talked to that double digit growth rate that you guys have had reference for 2020. So I understand that the underlying business right now is growing 19%, there is still a few moving pieces obviously between the sales reps returning back to productivity and what you referenced was kind of continued attrition, maybe three year end relative to where you guys finished 2018 with? So maybe you can talk through kind of the cadence of that as we move forward beyond just this year and then, are you guys looking at new products and new geographies as major driver as you go into 2020 and beyond.

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Yeah, sure. So from the side of looking at double-digit expected growth going into 2020, we aren't assuming any material contribution from new countries. So our focus still will be in the US and Europe as our primary market. Obviously, we do plan to continue to look for opportunities outside of there, but that really isn't contemplated in the numbers that we discussed here and that doesn't include any contribution in new areas like China. From new products, we are assuming a small, relatively small contribution associated with the New Aera product portfolio, which we are very excited to add to our product portfolio, although there is some additional R&D work there to get full use of the technology over the next couple of years, but we are assuming that does start to contribute in 2020. So on top of that, just in terms of cadence, obviously we're not given specific 2020 guidance today. It's very early for us to even comment on 2020. So we would expect the underlying seasonality trends to be similar to what we've seen in prior years with I know higher sales in the second and third quarter versus the fourth and first quarter, but outside of that, we need to get a little closer to the year before we comment on specific trends.

Margaret Kaczor -- William Blair -- Analyst

Okay. And then, in terms of the New Aera acquisition that you guys had referenced, there's a few products, I think in that category that have been out there and so if you looked at evaluating that market which asset was the right asset to target, why that -- is it something that's easier to incorporate into your device on your POC and that gives you that competitive advantage in the space. And then if you can give us a sense of the commercial model, if you're going to sell it D2C in a near-term. Do you guys have a sense of ASP or gross margin contributions for that, and then just [Indecipherable] one more in there, how do you expect, traditional NIV players to respond to kind of you guys entering the market with your unique combination. Thanks.

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah, I mean, we think that the New Aera product and technology fits perfectly with not only our oxygen product portfolio that we have today, but also is very complementary with our go-to-market strategy. The great thing about this product is that we liked about it is, not only the efficacy is proven in the clinical study -- peer-reviewed study that they ran, but also it's designed for patient preference and simplicity and ease of use, which is kind of our success formula for our POCs. So it's a product that we think that we can leverage our sales force, as well as our marketing spend because many of the current leads that we generate right now would be candidates for the New Aera product. So we can get some leverage there. It's an area where we have expertise in respiratory and oxygen therapy services. So for our first acquisition, it fits close to home. It also allows us to get into adjacent markets, downstream in the non-invasive ventilation for really the sicker patients that need ventilation in addition to oxygen therapy, but also upstream where we think that we can impact a portion of some of the basic COPD patients that have breathlessness, where really there isn't any coverage criteria or anything that they fit under, but it's a retail opportunity for us and we have a great retail model that we've proven over the last 10 years. So again, we think that fits nicely with our core competency and where we are unique.

As far as the channels we would sell it in, obviously, I just mentioned direct-to-consumer, we think it fits nicely there, it will also be a perfect fit for our physician, sales force something that they can showcase in front of doctors and we think that it could play a big role to get the product jump-started and get some exposure in pulmonary rehab facilities.

We've already seen that in the very limited sales that New Aera has actually had. They got their FDA clearance last year and just started to sell a small amount of products and then got to a point where it made sense to take -- to take this to the commercial stage that they would hand that off to somebody that had more horsepower, rather than develop that themselves.

Lastly, we will sell this to the business-to-business community, just like we do POCs. We want to use that community to broaden access to this product concept to patients, just like we do POCs. It's as I said patient preferred, but it's also relatively low cost, we think that cost in NIV is going to be more important as you look forward. If indeed, it remains included in the competitive bidding program and again we think that products that have kind of gone through that program where there is downward reimbursement pressure there's opportunity for disruption. As far as what other people are going to think that's probably, I'd, rather they answer what they're going to think. But I think that we've shown we're a strong competitor in POCs as a market leader, we've got a unique go-to-market strategy. We're going to leverage all of that horsepower to take full advantage of the TAV product and technology.

Margaret Kaczor -- William Blair -- Analyst

All right, thank you guys.

Operator

Our next question comes from J.P. McKim from Piper Jaffray. Please go with your question.

J.P. McKim -- Piper Jaffray -- Analyst

Hi, good morning. Thanks for taking my question. Can you just help me get to your kind of down Q3 guidance, I'm just playing around with the model and it's hard for me to get there, Is international the only segment that's going to grow?

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

I -- so we don't give specific guidance there but we did say on the call that we expect both domestic C2B and B2C to be down year-over-year. Rental will also have a headwind just associated with a strong Q3 and the change in both the rates that were effective January 1st, and the change in bad debt accounting that was effective January 1st. So those will all be headwinds to growth for us in Q3.

J.P. McKim -- Piper Jaffray -- Analyst

Okay. And then ask one I think like on the DTC side, like I think there's more attrition and maybe the productivity ramp didn't quickly ramp as you thought but the fact that resellers are down as well makes me think like there seems similar issues and like their business model probably hasn't changed in terms of selling on the direct channel as well. So maybe if you could just -- if we can talk about lead growth, whether that's still growing or anything that can give us a little more confidence that it's the leads are there, given that the resellers and you guys are seeing the same sort of problem on closing business.

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah, on the Internet reseller side, as I mentioned in my comments that they didn't see the seasonality benefits that we traditionally see. Now you have to remember, the Internet resellers are -- they're not investing for growth. They're typically, privately owned companies that focus generally more on bottom line than growth -- that's their model.

We can comment on what we've seen, because we don't have visibility exactly to what their leads are. We obviously see their sales patterns and talk to them about their struggles and things and they didn't see that uptick. It was kind of a -- if you look at it from a pure weather standpoint in the spring, it was a crummy spring with colder than it usually is and we usually see that uptick coincide with when the weather warms up. This was a little stranger weather pattern than we've seen in the past. and we saw consistently across all of them that they had a similar pattern that they didn't bump up. Now their purchases now are pretty consistent meeting our expectations of what we would expect right now, if we look at our own metrics that we've got, which is obviously we have a lot more visibility of our own than theirs. I go back to the inherent productivity gains that we were able to drive with our seasoned reps, our issues tended to be more with the reps that we are trying to bring up the curve. And as I said, there is unfortunately, a higher percentage of those reps that we're not successful than we anticipated. That is a disappointment, but it's one that we have to deal with. And we have kind of dealt with that through the second quarter.

Again, generating many thousands -- tens of thousands of leads every month, gives us the confidence that there is many, many patients out there, many more patients dragging around a tank that would like to be carrying a POC and it's our job to execute the sales and growth plan so that we can harvest that opportunity. That's what we'll do going forward. But obviously, if we thought that we were hitting a saturation point, we wouldn't be back to hiring more reps and expanding our capacity there. All the numbers that we have to say that we still have room to grow in oxygen therapy and we're going to continue to use that sales capacity to drive that growth.

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

And just to add a little bit on to that, that point on the Internet resellers. First of all, I do want to say that for the Internet resellers as a sub-section of the channel of domestic B2B, Q2 was there toughest comp year-over-year. Q2 last year was a very strong number for them as we also saw in our business as well. So I want to point out that, that was a very tough comp. I also want to point out that the resellers as a percent of our domestic B2B channel are less than a third of the total. So this is a smaller segment versus the traditional HME purchases that is the majority -- vast majority of the US B2B segment.

J.P. McKim -- Piper Jaffray -- Analyst

Thank you.

Operator

Our next question comes from Robbie Marcus from JP Morgan. Please go ahead with your question.

Robert Marcus -- JP Morgan -- Analyst

Thanks for the question. I was hoping you could just touch on -- you said that you're still getting high quality leads -- the reps just aren't able to act on them. What gives you confidence that they are high-quality leads? So what is it that's causing reps not to be able to act on them like they would have, let's say, a year ago? And what gives you the confidence that the new reps that you'll be hiring going forward will be able to act on them differently than the ones hired in 2018?

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah. It's a good question, Robbie. So again, we kind of measure things year-over-year to make sure it's apples-to-apples looking at what we call our seasoned reps. And if you look at the productivity, and close rates, and the success of our seasoned reps, they're actually improving and that's part of the productivity gain that we showed in the second quarter, that's really across the seasoned reps, as well as some of the newer reps that we were able to improve their performance. and they remained with the company.

Our real issue has been with a lot of the newer reps that we hired in 2018, where we frankly, just, in some cases, probably didn't hire the right people. We've tried and redoubled our efforts to retrain them and make them successful but it just comes down to -- some of them were not successful and they have transitioned out of the company, either of their own accord, or they didn't meet our performance expectations and we eventually took some steps to make changes. But when you measure it against our -- the same reps that were here year-over-over, were actually showing good productivity improvement.

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Yeah. just to elaborate on that a bit. When we look at the leads, they are randomly distributed to the reps, so it's not like reps have specific territories, and that the older reps would have -- maybe better performing lead quality sources. The reps for -- each individual rep will work leads from a variety of sources and from a variety of portions of the country. So, because of that random nature, you can really look at how the seasoned rep pool is performing for indications of lead quality that you may not see in a specific rep class. So that, I think is an important thing to understand when looking at performance and lead quality.

Robert Marcus -- JP Morgan -- Analyst

Okay. Just to follow up on that, so what will change going forward? And I guess maybe what is it about the reps that are seasoned and performing well, that's different than the reps that you hired last year? And what are you going to change going forward? I guess what gives you the confidence that things will change and the new reps will be more productive?

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah. So we've changed, our hiring criteria, our screening mechanisms to make sure that the people that we bring in are going to be as good a match as possible, have a high probability of success. Of course, it's never a guarantee that 100% of everybody you hire is going to work out, but certainly we had a higher percentage that didn't work out than we've had in the past. So that's hurt us and we've changed that intake criteria, we've changed our training. program, we changed our support, structure and the amount of support that we give people. And your question is a good one, what gives you confidence, I go back to the -- we have hired a couple classes and measuring those classes that we've hired against the areas where we had issues, we're seeing success in those classes already. Going forward, again, we're also going to hire in all three of our locations. So another key thing that we kind of found is that, those larger classes that we hired in the one single site, people don't get as much one-on-one time through training and on-boarding, so we're going to hire smaller classes. We'll give them that more one-on-one time, make sure that we've got enough management infrastructure to support them coming up the curve. And again, that follows our success formula that we've had in the past.

Robert Marcus -- JP Morgan -- Analyst

And if I could just sneak one more in here. Ali, we've seen operating margins decline in 2019? What gets it back to positive improvements? And is 2020 going to be another investment year or is that when we can start to see a tick back up? Thanks a lot.

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Yeah, I do expect us being able to show some improvement from the 2019 numbers. I do want to remind you that a portion of that change and guidance is associated with the cost for the New Aera transaction that wasn't in previous guidance. Really, what we need to do is execute on our B2C plans to improve their overall sales and marketing efficiencies. That is what's needed in order for us to show improving operating margin. We have been showing great leverage on R&D and G&A, but sales and marketing is really the focus areas to improve that particularly going into 2020

Operator

Our next question comes from Mike Matson from Needham and Company. Please go ahead with your question.

Mike Matson -- Needham and Company -- Analyst

Yeah. Thanks for taking my questions. I guess just wanted to start with the DTC sales force. So, I guess -- I know there's been some turnover, but I would imagine your numbers are probably [Phonetic] still up [Phonetic] significantly year-over-year. So let me know what number one if that's right. And then two, why not try to fix the issues with the reps that are still there that haven't turned over or left before you go out and start adding more reps, because I'd imagine you could still get some increased productivity, which would drive growth. It just seems like you're maybe putting the cart before the horse here by going -- already going out and trying to add more reps before you fix the problems that you have here.

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Yeah. So I'll take the first question and then I'll let Scott jump into the strategy side. So **Part 18**

Sales Representative headcount that we saw in Q2 of 2019 on average was down about 17%, compared to Q2 of 2018. So that was a significant headwind for us, was the loss of capacity on a year-over-year basis. And obviously, we're able to offset that with improved productivity of both on a smaller side, the actual improvement of the seasoned reps and then the non-seasoned coming up the curve as we have fewer people in the early stages of that productivity curve. But headcount was down significantly from a sales representative headcount side on a year-over-year basis in Q2. And as part of the challenge going into Q3 and Q4, particularly since we hired significantly in Q3 of last year, that headwind to D2C sales growth will get figure in Q3, because of that reduction in headcount on a year-over-year basis.

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah, and the second part of your question, Mike, why wouldn't we focus on the reps that are struggling as opposed to going back and hiring reps before you fix the issues. That's actually the process that we've worked through. We have been working with the reps that were struggling, really for the first half of this year. And working with them, that's where we peeling back the onion again, uncovered some deficiencies, through our training process, our support process. Those are things that you can fix, and let's say, apply to the reps that are already in place.

But there's also, frankly, issues with our screening process and we concluded and some reps also concluded themselves that they just weren't cut out for this job. And that's where the attrition comes in. So we've actually been trying very hard and thought that we would be more successful than it turns out that we were to make those reps more successful.

So we've corrected those fundamental issues. As I said, applied all of those changes to a couple of hiring classes. We are seeing success on those classes and that's why we're resuming hiring. We've actually started this week, and we have new classes in this week in three of our locations.

Mike Matson -- Needham and Company -- Analyst

Okay, I guess I'm just struggling with the math here, because my understanding was that you added about 70% to your rep count in the second half last year and now you're saying, not even lapping that yet you're saying you're down 17% from where you were in the first half. So that implies almost like a 100% reduction in your... no -- sorry, no --like a 50% reduction in your reps or something?

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Yeah. No, so the 70% increase that we saw was throughout all of 2018 in our rep. So we went from 263 sales reps at the end of 2017 to 446 at the end of 2018. Again, those are net numbers after attrition. So that increase of 70% was throughout 2018. When we look at our hiring rounds, we did hire throughout the year in 28 teams. So those increases were significant in those periods. Obviously, we did see a bump up in Q3 in our headcount trend, but there was significant hiring in the first half of 2018, as well.

Mike Matson -- Needham and Company -- Analyst

Okay, but the reps that you added in the second half of last year, are essentially completely gone and then more, right, because you're already down in the first half from where you were last...

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

So we do have standard attrition in the business, as well. So this is an inside call center that already -- you are having to deal with that attrition level to get back to your base business. So that's built into the numbers as well.

Mike Matson -- Needham and Company -- Analyst

All right, and then just your stock is down considerably, you do have a fair bit of cash on the balance sheet, I understand you want to do M&A, and you've done a deal now. But, would you consider buying back stock given the steep decline here that we've seen?

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah, I mean, we've had that discussion in the past and we think that the best use of capital for us is to continue to look at growth opportunities and drive growth. New Aera, as we mentioned is the first acquisition, obviously, in the short term, we're going to focus on integrating that business and harvesting that opportunity.But -- now, that's really not our plan right now to go do a buyback, it's to continue to look for those unique disruptive opportunities where we can leverage our go to market approach of patients first and direct to consumers and leverage that expertise of direct consumer marketing and drive growth in the future.

Mike Matson -- Needham and Company -- Analyst

Okay, and then just finally, can you update us on the rental strategy? I mean, you've made some comments about it. But, I guess, how big of a part of your business do you want that to become? And how much are you really going to try to promote that part of the business? I mean, is that something that could be 20%, 25% of your revenue at some point, I know --it'll take some time to get there, but..

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Yeah, so I'll take that one. So as we said on our first quarter call, we did make a small change, a slight change to our intake criteria. It wasn't meant to be large shift in our total strategy. So that combined with our focus on having a separate rental intake team that would just focused on patients who are interested in coming on rental services and separate that out from the sales team. We think that that will drive increased rentals over time. Now it takes some time to build up that rental intake team. We have continued to build out that team but we expect that to take through the end of this year for us to build out that rental intake teams. So that's why we expect really going into 2020 is when you start -- we'll start to see rental contributing at a higher level. However, our focus still is on direct-to-consumer sales as that is a higher margin business for us. So that will be the primary focus. So while we do expect rental revenue to increase -- grow into 20% to 25% of revenue is not realistic in the near or medium term.

Scott Wilkinson -- President, Chief Executive Officer and Director

Yeah. Let me add [Speech Overlap] Hey, Mike so, what rental does for us? It gives us broader access to the market, OK. And to the extent that we need to use that really depends on the traditional HME community. If they're able to continue to grow, make our product readily available to patients, it's probably obvious that more patients are going to want to access the product using a rental or Medicare insurance benefit then can pay cash. If they can help us there, then we probably don't push rental quite as hard. But if they can't, it's a way to make sure that patients aren't blocked from the market to access our product. And so there's kind of a -- it's a strategy to make sure that we have access, that patients have access. The other thing that it does is it, lets us better utilize the leads that we generate. And we've talked about that in the past that we want to drive more efficiency in lead utilization. So to the extent that we take on more rentals, we're able to utilize more of those leads that we pay for, but that's kind of how it fits in our business.

Mike Matson -- Needham and Company -- Analyst

Okay, that's helpful. Thank you.

Operator

And our next question comes from Matthew Mishan from KeyBanc. Please go ahead with your question.

Matthew Mishan -- KeyBanc Capital Markets -- Analyst

Thank you for squeezing me in guys. You've done a lot of work on pricing and elasticity of demand. Just how is that factoring in here? Is there a pricing headwind year-over-year? And are you getting the increased volume from a lower price point?

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Yeah. So we are in Q2 lapping the pricing trial. So Q3 should be a clean quarter for us on D2C pricing side versus what we saw in the prior year where we changed pricing in the middle of the second quarter of last year. We will continue to look at pricing over time, we'll do another pricing trial at some point in time. But so far pricing has not been a major concern on the D2C side, because, competitive products have not been priced at a discount to what we're currently offering.

Operator

And ladies and gentlemen, we've reached the end of the allotted time for today's question and answer session. I'd like to turn the conference call back over to management for any closing remarks.

Scott Wilkinson -- President, Chief Executive Officer and Director

Thank you. Well, this has been a challenging period for Inogen. We're committed to our mission of improving the freedom and independence of oxygen therapy patients. And we're focused on increasing our sales force, enhancing sales force productivity, and helping our home care partners overcome the restructuring challenges.

I also want to reiterate, we're very excited about the New Aera acquisition, as we believe it allows us to maintain our market leadership position while also allowing us to expand into new adjacent market opportunities to meet our goals and execute on our plan to return to double digit revenue growth in 2020. Thank you for your time today.

Operator

[Operator Closing Remarks]

Duration: 63 minutes

Call participants:

Matt Bacso -- Investor Relations Manager

Scott Wilkinson -- President, Chief Executive Officer and Director

Alison Bauerlein -- Founder, Chief Financial Officer and Executive Vice President, Finance

Danielle Antalffy -- SVB Leerink -- Analyst

Margaret Kaczor -- William Blair -- Analyst

J.P. McKim -- Piper Jaffray -- Analyst

Robert Marcus -- JP Morgan -- Analyst

Mike Matson -- Needham and Company -- Analyst

Matthew Mishan -- KeyBanc Capital Markets -- Analyst

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