Inogen, Inc

Greetings, and welcome to InnoGen's third quarter 2021 earnings release conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow a formal presentation. If anyone should require operator assistance during a conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Jason Sommer, General Counsel. Thank you. You may begin.

Thank you for participating in today's call. Joining me are CEO Nabeel Shabshab and CFO Ali Bowline. Earlier today, Intergen released financial results for the third quarter of 2021. This earnings release and Intergen's corporate presentation are currently available in the investor relations section of the company's website. As a reminder, the information presented today will include forward-looking statements, including, without limitation, statements about our growth prospects and strategies for 2021 and beyond, expectations related to our financial results for the fourth quarter and full year of 2021, our expectations with respect to supply challenges and cost inflation related to semiconductor chips, using our batteries and concentrators, our ability to create shareholder value by driving awareness of our products, expectations regarding our international and domestic sales channels, Expectations related to our rental channel, expectations related to our prescriber sales organization, including the expansion of the sales team and implementation of healthcare intelligence platforms and tools through our partnership with Ashfield Healthcare LLC. Hiring expectations, expectations regarding reimbursement and regulatory changes, our expectations regarding the market for our products, and the impact of the COVID-19 pandemic on our business and supply and demand for our product. in both a short-term and a long-term. The forward-looking statements in this call are based on information currently available to us as of today's date. 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. Action results may vary, and we disclaim any obligations to update these forward-looking statements, except as may be required by law. We have posted historical financial statements and our investor presentations 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 U.S. 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 Indigent'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. With that, I will turn the call over to Imogen's President and CEO, Nabil Shabshab. Nabil?

Thanks, Jason. Good afternoon, and thank you for joining our third fourth of 2021 conference calls. We continue to make progress to revise and begin implementing a clinically informed approach to innovation, product development, and our go-to-market strategy. Over the last several weeks, we announced an important new partnership with Ashfield to strengthen our commercial capabilities, and we appointed Dr. Stan Glaser as EVP and Chief Technology Officer to lead our R&D and engineering, in addition to his previous responsibility for medical affairs and regulatory affairs. At the same time, like others in the industry, we are navigating the challenges posed by the supply chain disruptions that are limiting our ability to meet demand and creating an inflationary cost environment, which is partially offset by price increases across all sales channels that was effective in September 2021. In the third quarter of 2021, we saw total revenue growth of 25.3% from the third quarter of 2020. primarily driven by sustained demand, improved average selling prices, and the reduced impact of the COVID-19 pandemic and related public health emergency, or PHE, versus the comparative period in the prior year. In addition, we believe oxygen therapy patient diagnosis rates are returning to historical levels due to the increased pulmonologist interactions that were reduced during the COVID-19 PHE. Due to supply chain constraints and in an effort to optimize financial results, We intentionally focus our available capacity on supplying our direct-to-consumer sales and rental channels and our international business-to-business sales channels, which you will see reflected in those results, while attempting to fulfill critical orders for our domestic business-to-business partners. We are pleased by our strong rental revenue growth and our improved direct-to-consumer sales revenue in the third quarter of 2021 versus the third quarter of 2020. Direct-to-consumer sales increased due to relatively strong demand, which improved sales representative productivity and average revenue per order versus the first quarter of 2020 when these metrics had seen a decline from prior periods associated with the COVID-19 pandemic. We believe that the improved metrics we saw in direct-to-consumer sales and rentals versus the comparative period in the prior years were primarily due to higher vaccination rates leading to increased desire for mobility, concurrent with the relaxation of closure orders related to the COVID-19 PHE, as well as improved consumer confidence. While in the short term, our outlook is impacted by certain supply chain constraints, we are proud of the actions we have taken to make structural improvement in our business, including our investment in our prescriber organization and other areas, productivity improvement in our direct-to-consumer channels, and increases in our average selling prices. In the last two quarters, demand for our products increased versus the competitive period in 2020, which led to improved revenue growth rates as we were able to also improve gross margin and adjusted EBITDA returns. We believe over the long term our strategy to optimize the commercial infrastructure and drive productivity while investing in clinical research and research and development will help us work towards our plan to return to sustainable double-digit revenue growth and profitability. Before we go through the third quarter financial results in more detail, I would like to provide an update on the impact of the supply chain disruptions primarily associated with the semiconductor chips used in our portable oxygen concentrators, or POCs, and batteries. Since our second quarter 2021 earnings call, we have continued to see this impact as shortages continue and costs rise. While we have been hard at work to help mitigate the impact of these shortages, it has and likely will continue to have a negative impact on our ability to fully meet demand in the quarters to come as these chips are used across all of our POCs in both batteries and printed circuit boards. We are continuing to work with our OEM partners and leveraging to the extent possible open market avenues to purchase the necessary semiconductor chips. The cost of these chips from third parties have trended significantly higher in the third quarter of 2021 than the cost seen in the second quarter of 2021 as a result of high demand for these chips and the costs are expected to continue to increase if and to the extent supply is available during the shortage. As a result, we saw inflated costs related to the acquisition of semiconductor chips begin to negatively impact our cost of goods sold in the first quarter of 2021, and we expect this to have an increased impact on our material costs in the fourth quarter of 2021 and continuing into 2022 until supply and demand get closer to equilibrium. Even though we paid significant costs in the first quarter of 2021 associated with these chips, Most of these costs increase prepaid expenses and inventory given that these components were not yet in the finished products that were sold during the period. We still believe, based on our assessment and industry feedback, that these supply shortages and increased costs may likely continue through the second quarter of 2022. In addition, the increased cost of goods sold per unit in the first and second quarter of 2022 is expected to be higher than the cost increase expected in the fourth quarter of 2021 based on the information known to date. This is a dynamic situation as component cost increase have exceeded our initial projections and open market availability of components are not guaranteed, which may lead to additional limitation on production if components are not available at agreeable prices. We expect demand to exceed supply for our products in the interim, but have taken the necessary measures to partially offset these rising costs by implementing price increases across products as of September 1, 2021. In addition to the semiconductor chip limitation, we are continuing to see supply chain challenges for other components used in our products, albeit to a lower degree. Thus far, we have been able to manage through these challenges with increased inventory levels and heightened supplier management and communication. With that, I will now provide details for our third quarter 2021 revenue by channel. For the third quarter of 2021, we generated total revenue of $93.1 million compared to $74.3 million in the third quarter of 2020. As I referenced earlier, this represents a robust increase of 25.3% over the comparative period in 2020. Domestic business-to-business sales in the third quarter of 2021 decreased 1.1% to $22.8 million compared to $23.1 million in the third quarter of 2020, primarily due to supply chain constraints that limited product availability in this channel. International business-to-business sales in the third quarter of 2021 increased by 49.7% or 46.9% on a constant currency basis, to $21.8 million compared to $14.6 million in the first quarter of 2020. Increase was primarily driven by increased emulation of patients in Europe and improving operational capacity of certain European respiratory assessment centers closer to normal levels, and improving COVID-19 vaccination rates enabled patients to return to more normalized activity levels and seek treatments. Domestic direct-to-consumer sales increased 24.6% to $36.3 million in the first quarter of 2021 from $29.2 million in the third quarter of 2020. The increase was primarily driven by increased demand for POCs due to higher COVID-19 vaccination rates and the relaxation of closure orders related to COVID-19 PHE leading to increased ambulation, as well as improved consumer confidence as compared to the third quarter of 2020. Inside sales representative productivity was strong in the quarter despite lower average inside sales representative headcount, which was down approximately 8% from the comparative period in the prior year as attrition outpaced hiring. In addition, sales in this channel were impacted by lower battery accessory sales in the period due to supply chain constraints. We continue to look to add new inside sales representatives while maintaining our hiring standards and being mindful of the supply chain constraints we are facing. We expect minimal net new inside sales representative hires in the near term due to the size and the quality of the candidate pool and expected attrition. But as part of our growth plans, we are increasing our focus on improving productivity of our existing inside sales force. Despite the lower headcount, we are pleased with the performance of our inside sales team in the third quarter as we saw improved direct-to-consumer sales productivity and increased average revenue per order versus the first quarter of 2020, including the price increase effective September 1, 2021. Rental revenue in the third quarter of 2021 increased 61.3% to $12.1 million from $7.5 million in the same period in 2020, primarily due to increased patients on service, higher billable patients as a percent of total patients on service, and higher Medicare reimbursement rates. As of September 30, 2021, we had approximately 40,400 patients on service, which was up 8.9%, sequentially compared to June 30, 2021, and up 36.9% compared to September 30, 2020. The increase in patients on service was primarily driven by greater utilization of patient leads for rental opportunities and physician-facing initiatives to increase prescriber awareness by our sales force, as well as the relaxed Medicare criteria for oxygen category reimbursement due to the COVID-19 PHE. Despite the supply chain challenges, we are still cautiously optimistic that our performance both in direct-to-consumer sales and rental channels is a positive indicator for improving market conditions of our products overall. I also want to provide an update on the recently announced agreement with Ashfield, our contract sales organization, to enhance our go-to-market capabilities in the U.S. The plan to add approximately 20 dedicated sales representatives to our prescriber sales organization is now underway. Additionally, Ashfield will provide access to its best-in-class data-driven sales management disciplines, proprietary cyber insights, and analytics to support a growth strategy and drive performance in the clinician sales channel. We are still in the early stages of ramping up this collaboration, but we expect to have these sales representatives hired and trained during the first half of 2022, including the rollout of new and enhanced processes, tools, and field support teams across our entire prescriber sales organization to help drive productivity and efficiency. We look forward to providing more updates around our clinical strategy and our investments as we move forward. Now turning to the latest from CMS, On September 27, 2021, CMS announced a final ruling on the home use of oxygen national coverage determination and removed the national coverage determination for home oxygen use to treat cluster headaches, largely in line with the proposed rule issued in July 2021. We are supportive of these changes and believe that expanded coverage for patients who would benefit from oxygen therapy, reduced administrative burdens, and greater physician decision-making authority on proper patient care can improve access for patients who are in need of oxygen therapy. Briefly, I'd like to also update you on the recently released Medicare traditional fee-for-service market data for the full year 2020. While the Medicare information has certain limitations when used to estimate the size and makeup of the oxygen therapy market, such as the absence of brand or manufacturer information, we believe that the information can serve to approximate the long-term oxygen therapy market in the United States. Based on the data set, we estimate that the share of POCs in the traditional fee-for-service Medicare long-term oxygen therapy market grew from 18 percent in 2019 to 20.9 percent in 2020. However, this estimate does not include patient cash sales or private insurance transactions, so we believe that this data from CMS may represent a conservative estimate of actual POC market penetration. POCs were still the fastest-growing modality in oxygen therapy based on the CMS data, and we still believe this category has a significant growth opportunity ahead. The data also showed a continued trend of a decreasing share of stationary concentrators, transferring devices, systems, liquid systems, and oxygen tanks. Due to the trend of a higher percentage of patients receiving both stationary and ambulatory oxygens, we have increased our estimate of target for penetration of total long-term oxygen therapy patients using POCs to be approximately 72%. This is up from our prior estimate of 70% and is based on our estimate that 90% of the ambulatory long-term oxygen therapy patients could be served by POCs over time. As we look ahead, Despite some near-term challenges, the underlying demand for our offerings is strong, and we are confident about our commitment and focus on increasing the POC market penetration and improving patient access. To that effect, we remain focused on strengthening patient awareness of our best-in-class POC offerings and expanding our efforts in terms of market development to increase awareness and advocacy of clinicians in support of POC-based oxygen therapy. We recently announced that Dr. Stan Glaser, Immigrant EVP and Chief Medical Officer, has been appointed to the role of EVP and Chief Technology Officer, responsible for R&D and engineering, medical affairs and regulatory affairs. Dr. Glaser brings extensive expertise in development and commercialization of combination drug device innovations, clinical development, medical and regulatory affairs, as well as market access across various disease states. In his new role, Stan will partner with the leadership team to drive clinically informed disciplines in innovation, product development, and go-to-market strategies. We also announced that Brenton Taylor, previously Imogen's EVP of Engineering, will be leaving Imogen after a transition period ending April 1, 2022. We are very grateful for Brenton's leadership and the significant role he has played in the founding of Imogen and bringing it to where it is today. In the meantime, we are committed to working through the ongoing supply challenges while we continue to invest in our infrastructure and enhance our clinical evidence, R&D, and commercial capabilities to strengthen our market leadership position and portable opportunity. While we are still early in these efforts, I believe that we are on the right path to create long-term, sustainable, and profitable growth and value creation. With that, I will now turn the call to our CFO, Ali Barla. Ali?

Thanks, Nabeel. As Nabeel noted, total revenue for the third quarter of 2021 was 93.1 million, representing an increase of 25.3% over the comparative period in 2020. Turning to gross margin, for the third quarter of 2021, total gross margin was 51.2% compared to 44.4% in the third quarter of 2020. Our sales revenue gross margin increased to 50.1% in the third quarter of 2021, versus 43.5% in the same period of 2020. The increase was primarily due to increased average selling prices. The increase was partially offset by higher cost of goods sold per unit in the quarter, primarily due to increased labor and overhead costs and material costs. The third quarter of 2021 included $0.9 million of higher material costs associated with open market purchases of semiconductor chips used in our batteries and POCs. Rental revenue gross margin increased to 58.9% in the third quarter of 2021 versus 52% in the third quarter of 2020, primarily due to higher billable patients as a percent of total patients on service, higher Medicare reimbursement rates, and lower service expense per patient on service, partially offset by higher depreciation expense per patient on service. As for operating expense, total operating expense increased to 41.3 million in the third quarter of 2021 versus 35 million in the third quarter of 2020, primarily due to increased personnel related expense and increased advertising costs. These increases were partially offset by a 1.9 million non-cash decrease in the change in fair value of the new era earn out liability versus the comparative period. Research and development expense increased to 3.8 million in the third quarter of 2021 compared to 3.5 million in the third quarter of 2020. primarily associated with increased personnel-related expense. Sales and marketing expense increased to $28.3 million in the third quarter of 2021, versus $22.9 million in the comparative period of 2020, primarily due to increased advertising costs, personnel-related expense, and other direct consumer sales and marketing costs. Media and advertising costs were $9.4 million in the third quarter of 2021, compared to $7.7 million in the third quarter of 2020. General and administrative expense increased to $9.3 million in the third quarter of 2021 versus $8.6 million in the third quarter of 2020, primarily due to increased personnel-related expense and increased consulting and legal expense, partially offset by a non-cash decrease in the change in fair value of the new era earn-out liability versus the comparative period. In the third quarter of 2021, we reported operating income of $6.4 million, adjusted EBITDA of $12.2 million, net income of $12.2 million, and income for diluted common share of 53 cents. Our tax provision or benefit from income taxes for interim periods has been historically determined using an estimate of our annual effective tax rate adjusted for discrete items, if any. We concluded that the annual effective tax rate method would not provide a reliable estimate for the period. Therefore, we utilize the discrete method, which treats the year-to-date period as if it were the annual period and determines the income tax expense to benefit on that basis. This resulted in recording a $6.2 million income tax benefit in the period. Finally, we ended the third quarter of 2021 with cash, cash equivalents, and marketable securities of $245.1 million with no debt outstanding. As Nabil mentioned, we paid significant additional costs in the third quarter of 2021 for the semiconductor chips purchased on the open market, but not yet sold and finished products, which increased our prepaid expense and other current assets and inventory as of September 30, 2021, by $12.1 million and $1.1 million, respectively. Now turning to our outlook, we continue to face a number of uncertainties caused by supply chain disruptions and increased costs of critical components previously discussed, as well as the ongoing and bearing impact of the COVID-19 pandemic. As a result, we are still not providing detailed guidance for the full year 2021, including our revenue, revenue mix, operating income or loss, and adjusted EBITDA estimates for such periods. However, we can provide some general context to our expectations for the fourth quarter of 2021. Due to the expected supply chain constraints impacting semiconductor chip supply, we expect total revenue in the fourth quarter of 2021 to be similar to revenue in the fourth quarter of 2020. While the expense $.9 million of higher material costs associated with open market purchases of semiconductor chips used in our batteries and POCs in the third quarter of 2021 We expect this cost to increase significantly in the fourth quarter of 2021 due to cost inflation of materials and labor throughout the supply chain, primarily related to the semiconductor chips, which have exceeded our initial expectations. We expect $5 to $7 million of higher material costs associated with open market purchases of semiconductor chips used in our batteries and POCs for a full year of 2021, including the costs incurred in the third quarter of 2021. which will vary based on total systems and batteries sold with semiconductor chips bought on the open market. At the same time, we are still committed to making multi-year investments in clinical research, research and development, and building the necessary infrastructure to support future revenue growth and predictability, as well as margin expansion. Given such investment initiatives, we expect increased operating expense for full year 2021 compared to 2020. In addition, while we incurred minimal expenses related to bonus and performance-based stock compensation expense in 2020, we expect such costs to increase in 2021 along with certain expenses related to the previously announced officer transitions and additions. In summary, we expect negative adjusted EBITDA and operating and net losses in the fourth quarter of 2021 and operating and net losses for full year 2021, reflecting the anticipated supply-constrained revenue decline increased cost of goods sold per unit, and higher operating expense in the period as compared to the first nine months of 2021. To reiterate what Nabil said earlier, while in the short term our outlook is impacted by certain supply constraints, we are proud of the actions we have taken to make structural improvements in our business, including our investments in our prescriber organizations and other areas, productivity improvements in our direct consumer channel, and increases in our average selling prices. In the last two quarters, demand for our products increased against the comparative periods in 2020, which led to improved revenue growth rates, and we were able to also improve gross margin and adjusted EBITDA returns. We believe over the long term, our strategy to optimize the commercial infrastructure and drive productivity while investing in clinical research and research and development will help us work toward our plan to return to sustainable double-digit revenue growth and profitability. With that, We'll be happy to take your questions.

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you'd like to ask your question, you may press star 1 on your telephone keypad. Confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. Our first question comes from the line of Robbie Marcus with JP Morgan. Please proceed with your question.

Oh, great. Thanks for taking the question. I was wondering, maybe you could start, do you have any sense of where demand would be if you didn't have supply issues now, and if there's any way to quantify what the demand side is? We know what the supply side is, but just trying to figure out what's going on in the underlying demand and what the delta is.

Yeah, sure, Robbie, I can take that question. We're not quantifying the specific backlog that we had as of the end of the quarter, but the backlog certainly was the largest in our domestic business-to-business channel. We are prioritizing our direct consumer business, so that channel had minimal backlog as of the end of the quarter. Of course, that channel was impacted by having the lower availability of batteries for sales, but outside of that, there's minimal impact to that channel. And our international business-to-business channel also had a backlog as of the end of the quarter, but it was smaller than our domestic business-to-business backlog. One of the challenges that we have, Robbie, in providing that number is that it does appear like this is across the entire industry that there are these shortages of oxygen therapy products. And so we believe that it has led to customers placing orders across multiple manufacturers to see what products would get filled first that may overstate the actual demand of products, just given the backlog and the lead times to fulfilling orders right now across the industry. But it was quite large at the end of the quarter. And, you know, we've continued to see strong demand going into the fourth quarter as well.

Got it. Okay. So, you know, you were able to this year control expenses pretty well to account for some of the top line. You know, do you plan to wait until – second quarter to start the direct-to-consumer advertising, start that sales engine again preemptively, or is it one of those you're going to wait to see when demand starts to catch up again? Just trying to think how we can, once supply resumes, what sort of recovery we can start to look forward to.

I'll take that one. Thanks for the question. As we said, the situation is very fluid. We are actually continuing to see the underlying demand to be strong and healthy. We are going to be monitoring things very closely and then decide accordingly in terms of we're not stopping advertising. We're going to continue to nurture that growth that we're seeing, but we're very cautious about managing the supply on a week-by-week basis, in all honesty, and then we'll make those decisions accordingly.

Okay, great. Look forward to it. Thanks for taking the questions.

No worries. Thank you.

Our next question comes from the line of Margaret Ketzer with William Blair. Please proceed with your question.

Hey, guys. This is Maggie Bowie on for Margaret today. I wanted to ask one just kind of building off of what Robbie asked. So based on what you're seeing today, do you expect that the current demand will be sustainable through next year? Because of the supply constraints, what are patients doing when they are unable to get a POC? Thanks.

So most patients, Maggie, if they're unable to get a POC, they are receiving tank-based oxygen therapy today. Of course, that also is the mass majority of the market, as we were talking about in the market statistics. So it is limiting the ability to convert to POCs from the tank-based system, and new patients are continuing to receive more tank-based systems than we would like. But that's really what most patients are receiving today.

Okay, got it. Thank you. And then I wanted to ask one on the Asheville partnership you guys announced. So how does this help accelerate your efforts to focus on the prescriber? And can this have a material impact on And then why is this the right time to do it, given that there are supply chain constraints limiting your ability to fill some of the demands?

I'll take that one. So it will have, so as we said, we expect the staff, the team to be staffed and trained in the first half of next year. We also acknowledge that there is a ramp up in terms of productivity. So this is the right time to do it. We also believe that simultaneously the supply chain concerns are going to start easing up as of the back half of the year. So it would be very timely in the sense that these sales people would have been in the field, would have established the relationships and are getting up to productivity. which typically is in the nine plus months. So it's absolutely the right time to make the investment. We also believe that it will have a material impact in the years to come, but starting in 2022, in the back half of the year, as people come up to that productivity that we're expecting. And it's as a result of a couple of things, the ability to scale, the higher discipline, and all the insights-driven approach in terms of targeting and selection to make sure we're calling on absolutely the right targets from a prescriber perspective are all going to be net net positive versus how we're doing things today.

Got it. Thanks so much.

Thanks, Sandy.

Our next question comes from the line of Danielle Antope with SVP Larrington. Please proceed with your question.

Hey, good afternoon, guys. Thanks so much for taking the question. And congrats on a solid quarter despite the supply constraint issues. I had a question on the B2B domestic side of things and just curious about how you guys see this evolving once we come out on the other end of COVID, which who knows, but hopefully happens somewhat in the near future. And I ask that question because, you know, a lot of these service providers and things like that are cash constrained and COVID's really hit everyone. And you have the whole dynamic of, of the investment in the infrastructure to shift to more of a POC versus stationary model and I mean, anything you can comment on that about how we should be thinking about the B2B business ramping back up on the domestic side once COVID is hopefully in the rearview mirror?

Yeah, so thanks, Danielle. I'll take that. So let me start with a little bit of context first. We believe that the B2B is actually in a backlog, not only from us, but from multiple suppliers because we are all in the same situation from a backlog perspective. And by the way, we are balancing like all the other manufacturers. We're balancing the channel mix a little bit just to make sure that we continue to supply B2B, but we also are optimizing our ability to hit the revenue growth number that we have, as you've seen in the quarter. So on the back end of it, as we are one of the major suppliers, we believe that we'll be in a better position to start resupplying that channel as much as we can ahead of other suppliers. And as things normalize, getting it back to where it used to be from a contribution to the overall sales that we have.

And just to add on to that, Danielle, we have seen improving reimbursement rates in oxygen therapy as well as you know, the new NCD, which expands patient access to oxygen therapy. So I do think that those are two positive trends for both us and our partners on the B2B side that will allow people to continue to be interested in the oxygen therapy space and expanding the patient population. You know, it has not been announced yet. Usually it's announced in December what the inflation adjustment will be for oxygen therapy. So that's something to look forward to as well as, you know, obviously cost increases have hit the providers across the board as well. And then, of course, there's the proposed ruling of what they're going to do once the PHE is over with pricing and oxygen therapy. So, we hope that, you know, the industry voice is heard that, you know, those rates should continue to increase given the value of oxygen therapy and the very low cost of reimbursement that's in place today. I would hope that those would be positive trends for the overall market over time as well.

Got it. And then... Just one quick follow-up, and I apologize if I miss this, but in the direct-to-consumer and in the cash sale and rental business, did you guys talk about the rep productivity and how that's trending, really thinking about lead generation and then more specifically lead closure rates and just how that's trended? I appreciate, you know, you're operating under a supply constraint dynamic, but... anything you can provide there. Thanks so much.

Yeah, sure, Danielle, I can take that. So on the productivity side, we have seen improved productivity of the direct consumer team as we've kind of lost the COVID headwinds. So obviously during COVID, we had seen a reduction in close rates and also a reduction in interest in additional accessories and lifetime warranties. Those trends did rebound starting late in the first quarter of 2021, continued very strong in the second quarter. As you know, our business has normal seasonality in it. So we did see that normal seasonality pattern where the third quarter came down from the second quarter in terms of close rates in the period. But in both the second and third quarters, those close rates were an improvement, a significant improvement year over year for that channel.

So, Danielle, in addition, as we said in the previous remarks, this is a major focus for us and what we're going to actually, we are actually working on it actively now. We're bringing together a combination of insights plus tools plus heightened sales management discipline that will continue to focus on driving the productivity. We believe that there is room for growth by just continuing to focus on these areas and do them a little bit more with rigor and discipline.

Thank you.

Our next question comes from the line of Mike Mattson with Needham & Company. Please proceed with your question.

Yeah, thanks for taking my questions. You know, I want to ask about pricing. I joined the call a little late, so maybe there were some comments earlier in the call, but I think on the last call you talked about raising prices in response to the cost pressure. So, one, did you do that? Two, what was the timing? And three, how was it sort of received across the different channels that you're selling into?

Hey, Mike, thank you for the question. On pricing, we actually did exactly what we had laid out on the call last quarter. We took pricing in September. We took a low double-digit price increase across all channels. We had indicated before that we believe about 70% of it will actually stick due to either contractual commitments and or timing. We've seen that actually become a reality. And also from a context perspective, we've seen multiple competitors actually follow us in the price increase. because everybody is under the same pressure like we were. So, so far, it stands out exactly like we planned it.

Okay, got it. And then if you're looking at sort of $74 million, roughly speaking, in the fourth quarter, is that – I know you're not giving guidance for next year, but is that kind of your quarterly – capacity-constrained run rate. So, should we be modeling something similar to that kind of for the early part of 2022? Yeah.

So, I think we're not, you know, going to be giving 2022 guidance today. Frankly, just given the uncertainty on the supply chain, it still is a very fluid situation. And, you know, we do expect that our supply will continue to ramp from here. So, While we see Q4, that should certainly be a low point in terms of our expectations, and we do expect to get back to growth in 2022 at a high level.

So, Mike, go ahead. I'll add a couple of comments. As you see from our results, it's very fluid, but we're managing through it. However, it's like a weekly conversation. There's multiple updates every week. We're putting a lot of pressure on suppliers. So once these things clear out, we'll get back to that place where everybody likes us to be in terms of guiding. But for the time being, for very valid reasons, we're managing on a week-by-week basis. And while being very judicious, that's the way it is now.

Okay, got it. Thank you.

Our next question comes from the line of Matthew Mission with KeyBank. Please proceed with your question.

Hey, good afternoon, guys, and thank you for taking the question. I just wanted to start with trying to reconcile the material cost and the prepaid expenses and make sure I understand the change in profitability from 3Q to 4Q. When you say that you have $5 to $7 million of higher material costs for semis and batteries, including $1 million in 3Q, does that mean the remainder of that is coming through in the fourth quarter? And then how does that reconcile with the $12 million in prepaid expenses you were talking about? Is that included in that, or is that separate?

Yeah, great question. Thanks for allowing us to clarify this. Yes. In the third quarter, we incurred 0.9 million of higher material costs associated specifically with the semiconductor chips. And as we talked about in the guidance, we expect 5 to 7 million of higher material costs for the full year associated with chips for our batteries and POCs. So if you took 0.9 million or approximately a million off of that, that's what you would expect in the fourth quarter since there were no costs incurred in the first or second quarter of 2021 associated with these higher material costs. Now, as you rightly referred to, we talked about the cash utilization of using, you know, having additional cash associated with these chip shortages, and that is because we are also buying some of these chip shortages for usage in 2022. So, that additional cost would eventually have to be recognized on the P&L in higher cost, going into 2022.

Okay. I understand. And then just in the bill, I understand you have the agreement with Ashfield coming online. That's going to take a while, but I think you already had 20 or 25 direct to physician reps already in the system. How are you prioritizing demand to support that sales force and as this occurs over the next couple of quarters? And just how are they doing with the recovery in patient diagnosis as well as your focus on making sure that this is an important driver for the future of imaging?

Yeah, so I think you've said the most important thing at the end. It's a major driver for the future. We've talked about the strategy moving forward Let me address the first question about demand. How are we going to be able to meet the demand? The bulk of the referrers that will get there are going to be filled from a rental perspective, and that's one of the channels that we're prioritizing. So as the current sales force plus the additional 20 get up to speed, we are going to be in a position to prioritize that channel to make sure that we meet the demand in it. Back to the conversation around, okay, so what's the plan moving forward in terms of the coverage that we have? and I think we've had that discussion a little bit before. We believe that today the total universe is about 14,000 to 15,000 prescribers, but the bulk of them are pulmonologists and cardiologists. We plan on covering about a third of the high-special map, just to make sure that eventually with the combined sales forces and the concierge service, we cover about a third of that market. So that's the plan moving forward, and that's why we believe that that is going to become one of the significant pillars for our growth. And then we had indicated before that as we see the results starting to come through, we've always said that we're going to get that sales force a little bit further up north of the number that we have today, but that's the plan moving forward. But I will stress one thing. I think if you do some math in your head, we're going to get to – doubling the current coverage we have, but actually getting to a, by only increasing 50% of the sales force that we have.

And then my last question, as you kind of exit 21, the balance sheet still seems to be very strong. You're not bleeding cash to any extent, even with the supply chain issues. What do you need to see with your business? What are the prerequisites for you to be able to start pulling the trigger on some strategic M&A that could help you guys out and broaden out the product portfolio?

From that, we've always talked about two parallel runways. We're working hard on increasing the productivity and getting the basics reassured up on the core business. But we're simultaneously in parallel looking for opportunities to diversify the portfolio, of course. So that is an ongoing effort. We continue to look at potential additive components or targets that strategically fit the very strict criteria that we've developed. So we are openly looking at that as we continue to fix the core business. And as you see, increasing productivity and making sure that we deliver on the promises we have.

Excellent. Thank you very much.

Thank you, Matt.

Our next question comes from the line of Matthew Blackman with Stiefel. Please proceed with your question.

Good afternoon, everybody. Apologies in advance. I've been up and around calls here, so some of these questions may have been addressed. But I'll give it a shot anyway. Just curious on the supply chain, just how dynamic is sort of the environment? Does it change daily or weekly? And how much sort of visibility or how much more visibility perhaps do you have today versus, let's say, several months ago? And I I'm not necessarily talking about disability towards a more normal environment, but just disability on what you're going to be able to get your hands on in the next couple of weeks or months, just your ability to forecast.

So, Matt, I'm going to take that one. So I don't want to dramatize, so I'm going to call it weekly. But even though we have conversations on a daily basis, sort of the average time that we look at changes is on a weekly basis. And I'm going to point to two things, basically. We're trying to work actively through, can I get the sources? Are they available and will be shipped as promised? And are they authentic or not? Because we're sourcing all our needs today from the open market. The dynamics have not so far changed in terms of regular supply channels. So I think you asked a question about the outlook. Just recently, in the last few days, we've seen a little bit of more willingness to be transparent, in terms of the regular supply channels. It doesn't mean that we've had firm commitments on that, but we're beginning the conversations around trying to nail down some of the promises in terms of shipment dates. We'll see where we fair out, so it's dynamic in nature. We might go through the conversations and end up being a little bit disappointed, but we're working that channel. And then on the open channel, we're seeing now after a little bit of a very tough period, we're seeing some relaxation. in terms of available quantities. Now, the other two criteria, will they shift on time as promised, and are they authentic, which we go through a very, very thorough evaluation process. Those two things are always variable within the weekly milestones that we look at.

Okay, I really appreciate that, Kala. And then maybe, Ali, rental gross margins continue to march higher. Where can those ultimately go, I think is the question I'm asking.

Yeah, we're really proud of the fact that we've been able to continue to show improving rental gross margin percentage. You know, I think given the current race, I think we'll continue to see small incremental improvements there. But we are looking to see what, you know, as we talked about in a prior question, you know, what will happen with inflation adjustments and pricing after the PHE is over. So those are the two, I'd say, major potential changes in growth margin, but we are very proud of the impact we've had and continue to expect incremental improvement there.

All right, thank you so much.

There are no further questions in the queue. I'd like to hand the call back to management for closing remarks.

Okay, thank you. I'm encouraged by the revenue growth we saw in the third quarter of 2021, and I believe the strong underlying demand for our industry-leading solutions, coupled with the multi-year investments that we are making, will position us to reach our vision of becoming a global market leader with innovative, evidence-based chronic respiratory care solutions. Thank you for your time today, and I look forward to engaging conversations with our investors as we make progress on our strategy to build a stronger image. Have a good day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.