insp-20200630

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, DC 20549

______________________________

FORM 10-Q

________________________________


(Mark One)
☒			QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2020 or

☐			TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

Commission File Number: 001-38468

______________________________

Inspire Medical Systems, Inc.

(Exact name of registrant as specified in its charter)

______________________________


Delaware			26-1377674
(State or other jurisdiction of incorporation or organization)			(I.R.S. Employer Identification No.)
5500 Wayzata Blvd., Suite 1600 Golden Valley, MN			55416
(Address of principal executive offices)			(Zip Code)

Registrant's telephone number, including area code: (844) 672-4357

____________________________________________________________________________

Securities registered pursuant to Section 12(b) of the Act:

Title of each class

Trading Symbol(s)

Name of each exchange on which registered

Common Stock, $0.001 par value per share

INSP

New York Stock Exchange

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company," and "emerging growth company" in Rule 12b-2 of the Exchange Act.

Large accelerated filer ☒

Accelerated filer ☐

Non-accelerated filer ☐

Smaller reporting company ☐

Emerging growth company ☐

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of July 28, 2020, the registrant had 26,800,071 shares of common stock, $0.001 par value per share, outstanding.

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PART I.

FINANCIAL INFORMATION

Item 1.

Financial Statements

Balance Sheets

Statements of Operations and Comprehensive Loss

Statements of Stockholders' Equity

Statements of Cash Flows

Notes to Financial Statements (unaudited)

Item 2.

Management's Discussion and Analysis of Financial Condition and Results of Operations

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

Item 4.

Controls and Procedures

Unregistered Sales of Equity Securities and Use of Proceeds

Item 3.

Defaults Upon Senior Securities

Item 4.

Mine Safety Disclosures

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933, as amended (the "Securities Act") and Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). All statements other than statements of historical facts contained in this Quarterly Report, including statements regarding our future results of operations and financial position, business strategy, the impact of the ongoing and global COVID-19 pandemic on our business, financial results and financial position, prospective products, product approvals, research and development costs, timing and likelihood of success, other insurance providers' plans to begin approving our Inspire therapy, and the plans and objectives of management for future operations are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

In some cases, you can identify forward-looking statements by terms such as ‘‘may,’’ ‘‘will,’’ ‘‘should,’’ ‘‘expect,’’ ‘‘plan,’’ ‘‘anticipate,’’ ‘‘could,’’ ‘‘intend,’’ ‘‘target,’’ ‘‘project,’’ ‘‘contemplate,’’ ‘‘believe,’’ ‘‘estimate,’’ ‘‘predict,’’ ‘‘potential’’ or ‘‘continue’’ or the negative of these terms or other similar expressions, although not all forward-looking statements contain these words. The forward-looking statements in this Quarterly Report are only predictions and are based largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition, and results of operations. These forward-looking statements speak only as of the date of this Quarterly Report and are subject to a number of known and unknown risks, uncertainties and assumptions, including, but not limited to:

•our history of operating losses and dependency on our Inspire system for revenues;

•commercial success and market acceptance of our Inspire therapy;

•our ability to achieve and maintain adequate levels of coverage or reimbursement for our Inspire system or any future products we may seek to commercialize;

•competitive companies and technologies in our industry;

•the impact on our business, financial condition and results of operation from the ongoing and global COVID-19 pandemic, or any other pandemic, epidemic or outbreak of an infectious disease;

•our ability to expand our indications and develop and commercialize additional products and enhancements to our Inspire system;

•future results of operations, financial position, research and development costs, capital requirements, and our needs for additional financing;

•our dependence on third-party suppliers and contract manufacturers;

•risks related to consolidation in the healthcare industry;

•our ability to accurately forecast customer demand for our Inspire system and manage our inventory;

•our ability to expand, manage, and maintain our direct sales and marketing organization, and to market and sell our Inspire system in markets outside of the United States;

•our ability to manage our growth;

•our ability to hire and retain our senior management and other highly qualified personnel;

•risks related to product liability claims and warranty claims;

•our ability to address quality issues that may arise with our Inspire system;

•our ability to successfully integrate any acquired companies;

•changes in global macroeconomic conditions;

•any failure of information technology systems, processes or sites or damage to our physical facilities;

•our ability to commercialize or obtain regulatory approvals for our Inspire therapy and system, or the effect of delays in commercializing or obtaining regulatory approvals;

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•any violations of anti-bribery, anti-corruption, and anti-money laundering laws;

•risks related to our indebtedness;

•our ability to use our net operating losses and research and development carryforwards;

•the risk that we may be deemed to be an investment company under the Investment Company Act of 1940;

•U.S. Food and Drug Administration ("FDA") or other United States or foreign regulatory actions affecting us or the healthcare industry generally, including healthcare reform measures in the United States and international markets;

•our ability to establish and maintain intellectual property protection for our Inspire therapy and system or avoid claims of infringement;

•risks related to our ceasing to qualify as a smaller reporting company or an emerging growth company;

•risks related to our common stock; and

•other important factors that could cause actual results, performance or achievements to differ materially from those contemplated that are found in "Part I, Item 1. Business," "Part I, Item 1A. Risk Factors," and "Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 as updated by “Part II, Item 1A. Risk Factors” and “Part I, Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations" in this Quarterly Report on Form 10-Q.

Moreover, we operate in an evolving environment. New risk factors and uncertainties may emerge from time to time, and it is not possible for management to predict all risk factors and uncertainties.

You should read this Quarterly Report and the documents that we reference in this Quarterly Report completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise.

Unless the context requires otherwise, references to “Inspire,” the “Company,” “we,” “us,” and “our,” refer to Inspire Medical Systems, Inc.

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PART I—FINANCIAL INFORMATION

Item 1. Financial Statements.

INSPIRE MEDICAL SYSTEMS, INC.

BALANCE SHEETS

(in thousands, except share and per share amounts)


	June 30, 2020		December 31, 2019
	(Unaudited)
Assets
Current assets:
Cash and cash equivalents	$	211,237	$	22,860
Investments, short-term	31,322		126,605
Accounts receivable, net of allowance for credit losses of $34 and $48, respectively	10,235		13,131
Inventories	9,966		5,834
Prepaid expenses and other current assets	4,348		2,206
Total current assets	267,108		170,636
Investments, long-term	—		6,276
Property and equipment, net	3,307		3,045
Operating lease right-of-use asset	424		915
Other non-current assets	469		381
Total assets	$	271,308	$	181,253
Liabilities and stockholders' equity
Current liabilities:
Accounts payable	$	5,103	$	4,459
Accrued expenses	7,939		12,397

Total current liabilities	13,042		16,856
Notes payable	24,632		24,522
Other non-current liability	40		40
Total liabilities	37,714		41,418
Stockholders' equity:
Preferred Stock, $0.001 par value, 10,000,000 shares authorized; no shares issued and outstanding at June 30, 2020 and December 31, 2019	—		—
Common Stock, $0.001 par value per share; 200,000,000 shares authorized; 26,751,091 and 24,107,350 issued and outstanding at June 30, 2020 and December 31, 2019, respectively	27		24
Additional paid-in capital	452,891		319,865
Accumulated other comprehensive income	154		102
Accumulated deficit	(219,478)		(180,156)
Total stockholders' equity	233,594		139,835
Total liabilities and stockholders' equity	$	271,308	$	181,253

The accompanying notes are an integral part of these unaudited financial statements.

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INSPIRE MEDICAL SYSTEMS, INC.

STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (Unaudited)

(in thousands, except share and per share amounts)


	Three Months Ended June 30,						Six Months Ended June 30,
	2020		2019		2020		2019
Revenue	$	12,183	$	18,032	$	33,530	$	34,282
Cost of goods sold	1,954		3,094		5,251		5,948
Gross profit	10,229		14,938		28,279		28,334
Operating expenses:
Research and development	6,062		2,846		11,500		5,449
Selling, general and administrative	26,981		20,268		56,033		39,838
Total operating expenses	33,043		23,114		67,533		45,287
Operating loss	(22,814)		(8,176)		(39,254)		(16,953)
Other (income) expense:
Interest income	(248)		(1,036)		(890)		(2,122)
Interest expense	526		523		1,051		1,060
Other (income) expense, net	(3)		(13)		(81)		25
Total other (income) expense	275		(526)		80		(1,037)
Loss before income taxes	(23,089)		(7,650)		(39,334)		(15,916)
Income taxes	—		—		—		—
Net loss	(23,089)		(7,650)		(39,334)		(15,916)
Other comprehensive loss:
Unrealized (loss) gain on investments	(141)		35		52		103
Total comprehensive loss	$	(23,230)	$	(7,615)	$	(39,282)	$	(15,813)
Net loss per share, basic and diluted	$	(0.88)	$	(0.32)	$	(1.56)	$	(0.67)
Weighted average common shares used to compute net loss per share, basic and diluted	26,289,272		23,753,647		25,227,574		23,598,466

The accompanying notes are an integral part of these unaudited financial statements.

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INSPIRE MEDICAL SYSTEMS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)

(in thousands, except share amounts)


	Six Months Ended June 30, 2020
	Common Stock
	Shares	Amount		Additional Paid-In Capital		Accumulated Other Comprehensive Income (Loss)		Accumulated Deficit		Total Stockholders' Equity
Balance at December 31, 2019	24,107,350	$	24	$	319,865	$	102	$	(180,156)	$	139,835
Stock options exercised	254,142	—		787		—		—		787
Issuance of common stock	897	—		72		—		—		72
Stock-based compensation expense	—	—		2,749		—		—		2,749
Other comprehensive income	—	—		—		193		—		193
Adoption of ASU 2016-13, Financial Instruments - Credit Losses	—	—		—		—		12		12
Net loss	—	—		—		—		(16,245)		(16,245)
Balance at March 31, 2020	24,362,389	24		323,473		295		(196,389)		127,403
Stock options exercised	70,853	—		732		—		—		732
Issuance of common stock	1,119	—		73		—		—		73
Sale of common stock from follow-on public offering, net of offering expenses	2,300,000	3		124,651		—		—		124,654
Issuance of common stock for employee stock purchase plan	16,730	—		1,059		—		—		1,059
Stock-based compensation expense	—	—		2,903		—		—		2,903
Other comprehensive loss	—	—		—		(141)		—		(141)
Net loss	—	—		—		—		(23,089)		(23,089)
Balance at June 30, 2020	26,751,091	$	27	$	452,891	$	154	$	(219,478)	$	233,594

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INSPIRE MEDICAL SYSTEMS, INC.

STATEMENTS OF STOCKHOLDERS' EQUITY (Unaudited)

(in thousands, except share amounts)


	Six Months Ended June 30, 2019
	Common Stock
	Shares	Amount		Additional Paid-In Capital		Accumulated Other Comprehensive (Loss) Income		Accumulated Deficit		Total Stockholders' Equity
Balance at December 31, 2018	23,401,675	$	23	$	310,941	$	(52)	$	(146,913)	$	163,999
Stock options exercised	100,089	1		165		—		—		166
Issuance of common stock	1,246	—		58		—		—		58
Stock-based compensation expense	—	—		1,391		—		—		1,391
Other comprehensive income	—	—		—		68		—		68
Net loss	—	—		—		—		(8,266)		(8,266)
Balance at March 31, 2019	23,503,010	24		312,555		16		(155,179)		157,416
Stock options exercised	378,490	—		604		—		—		604
Issuance of common stock	1,043	—		58		—		—		58
Issuance of common stock for employee stock purchase plan	18,187	—		637		—		—		637
Stock-based compensation expense	—	—		1,389		—		—		1,389
Other comprehensive income	—	—		—		35		—		35
Net loss	—	—		—		—		(7,650)		(7,650)
Balance at June 30, 2019	23,900,730	$	24	$	315,243	$	51	$	(162,829)	$	152,489

The accompanying notes are an integral part of these unaudited financial statements.

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INSPIRE MEDICAL SYSTEMS, INC.

STATEMENTS OF CASH FLOWS (Unaudited)

(in thousands)


	Six Months Ended June 30,
	2020		2019
Operating activities
Net loss	$	(39,334)	$	(15,916)
Adjustments to reconcile net loss:
Depreciation and amortization	375		209
Accretion of investment discount	(88)		(609)
Accretion of debt discount	110		161
Non-cash lease expense	491		433
Stock-based compensation expense	5,652		2,780
Non-cash stock issuance for services rendered	145		116
Other, net	(98)		(141)
Changes in operating assets and liabilities:
Accounts receivable	2,905		(2,801)
Inventories	(4,131)		(894)
Prepaid expenses and other current assets	(2,233)		(4,284)
Accounts payable	639		(745)
Accrued expenses and other liabilities	(4,459)		(2,135)
Net cash used in operating activities	(40,026)		(23,826)
Investing activities
Purchases of property and equipment	(636)		(1,233)
Purchases of investments	(14,907)		(101,037)
Proceeds from sales or maturities of investments	116,703		79,204
Net cash provided by (used in) investing activities	101,160		(23,066)
Financing activities
Payment of debt fees	—		(531)
Proceeds from the exercise of stock options	1,519		769
Proceeds from the sale of common stock	124,654		—
Proceeds from issuance of common stock from employee stock purchase plan	1,059		637
Net cash provided by financing activities	127,232		875
Effect of exchange rate on cash	11		(3)
Increase (decrease) in cash and cash equivalents	188,377		(46,020)
Cash and cash equivalents at beginning of period	22,860		97,288
Cash and cash equivalents at end of period	$	211,237	$	51,268
Supplemental cash flow information
Cash paid for interest	$	947	$	1,087

The accompanying notes are an integral part of these unaudited financial statements.

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

1. Organization

Description of Business

Inspire Medical Systems, Inc. is a medical technology company focused on the development and commercialization of innovative and minimally invasive solutions for patients with obstructive sleep apnea ("OSA"). Our proprietary Inspire system is the first and only United States ("U.S.") Food and Drug Administration ("FDA") approved neurostimulation technology that provides a safe and effective treatment for moderate to severe OSA. Inspire therapy received premarket approval ("PMA") from the FDA in April 2014 and has been commercially available in certain European markets since November 2011. In June 2018, Japan's Ministry of Health, Labour and Welfare approved Inspire therapy to treat moderate to severe OSA, and we are currently seeking reimbursement coverage in Japan.

2. Summary of Significant Accounting Policies

Basis of Presentation

The accompanying financial statements have been prepared without audit, pursuant to the rules and regulations of the Securities and Exchange Commission (“SEC”). The financial statements may not include all disclosures required by U.S. generally accepted accounting principles ("U.S. GAAP"); however, we believe that the disclosures are adequate to make the information presented not misleading. These unaudited financial statements should be read in conjunction with the audited financial statements and the notes thereto included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

In the opinion of management, all adjustments, consisting of only normal recurring adjustments that are necessary to present fairly the financial position, results of operations, and cash flows for the interim periods, have been made. The results of operations for the interim periods are not necessarily indicative of the operating results for the full fiscal year or any future periods. Certain prior period amounts have been reclassified to conform to the current presentation. These reclassifications had no material effect on the reported results of operations.

Follow-On Public Offering

On April 16, 2020, we completed a follow-on offering that included our offer and sale of 2,300,000 shares of common stock at a public offering price of $58.00 per share. We received net proceeds of approximately $124.7 million after deducting underwriting discounts and commissions and offering expenses.

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts and disclosures reported in the financial statements. We use significant judgment when making estimates related to the allowance for credit losses, inventory reserves, warranty reserves, and the valuation of stock-based awards. We base our estimates on historical experience and on various other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results could differ from those estimates.

Cash and Cash Equivalents

We consider all highly liquid securities, readily convertible to cash, that mature within 90 days or less from the date of purchase to be cash equivalents. The carrying amount reported in the balance sheets for cash is cost, which approximates fair value.

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

Foreign Currency

Sales and expenses denominated in foreign currencies are translated at average exchange rates in effect throughout the year. Foreign currency transaction gains and losses are included in other (income) expense, net in the statements of operations and comprehensive loss. Assets and liabilities of foreign operations are remeasured at period-end exchange rates with the impacts of foreign currency remeasurement recognized in other (income) expense, net in the statements of operations and comprehensive loss.

Investments

At June 30, 2020 and December 31, 2019, our short-term investments consisted of commercial paper, corporate bonds, asset-backed securities, and U.S. government securities which are classified as available-for-sale and had maturities less than one year. Our long-term investments consisted of corporate bonds. Investments are reported at their estimated fair market value which are based on quoted, active or inactive market prices when available. Any unrealized gains and losses due to interest rate fluctuations and other external factors are reported as a separate component of accumulated other comprehensive income. We had $0.2 million and $0.1 million of unrecognized income in accumulated other comprehensive income at June 30, 2020 and December 31, 2019, respectively. Any realized gains and losses are calculated on the specific identification method and reported net in other (income) expense. For both the three months ended June 30, 2020 and 2019, we recognized no realized gains, net. For the six months ended June 30, 2020 and 2019, we recognized $0.1 million and $0 of realized gains, net, respectively.

We recognize expected credit losses on investments in accordance with Accounting Standards Update ("ASU"), ASU 2016-13, Financial Instruments - Credit Losses ("ASU 2016-13"), which we adopted effective January 1, 2020 using the modified retrospective approach. The adoption of ASU 2016-13 did not have a material impact on the amount and timing of credit losses recognized in our financial statements.

We reassess our estimated credit losses on investments each reporting period. U.S. government securities and cash equivalents are under a "zero-loss exception" for credit losses, meaning no credit loss risk calculation is necessary on those instruments due to the exceptionally low rate of default, which continues to decrease as the securities approach maturity, which for us is no longer than two years. For non-U.S. government securities, we use a discounted cash flow approach to calculate expected credit losses using estimated default rates based upon historical loss data, current conditions, as well as expectations of future economic conditions. We record changes in the allowance for credit losses for available-for-sale debt securities with a corresponding adjustment in credit loss expense on the statement of operations and comprehensive loss. No reversal of a previously recorded allowance for credit losses may be made to an amount below zero. The total allowance for credit losses was $0 at June 30, 2020.

Fair Value of Financial Instruments

We measure certain financial assets and liabilities at fair value on a recurring basis, including cash equivalents and investments. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or a liability. A three-tier fair value hierarchy is established as a basis for considering such assumptions and for inputs used in the valuation methodologies in measuring fair value:

Level 1—Observable inputs, such as quoted prices (unadjusted) for identical assets or liabilities in active markets.

Level 2—Other inputs that are based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant inputs are observable in the market or can be derived from observable market data. Where applicable, these models project future cash flows and discount the future amounts to a

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

present value using market-based observable inputs, including interest rate curves, foreign exchange rates, and credit ratings.

Level 3—Unobservable inputs that are supported by little or no market activities, which would require us to develop our own assumptions.

We use the methods and assumptions described below in determining the fair value of our financial instruments.

Money market funds: Fair values of money market funds are based on quoted market prices in active markets. These are included as Level 1 measurements in the tables below.

Commercial paper: Short-term, highly liquid investments are included as a Level 2 measurement in the tables below.

Corporate bonds: Consists of short- and long-term notes and bonds with various yields. These are included as a Level 2 measurement in the tables below.

Asset-backed securities: Consists of short-term, securitized investments backed by pools of credit card receivables. These are included as a Level 2 measurement in the tables below.

U.S. government securities: Consists of U.S. government Treasury bills and notes with original maturities of less than two years. These are included as a Level 1 measurement in the table below.

The following tables sets forth by level within the fair value hierarchy our assets that are measured on a recurring basis and reported at fair value as of June 30, 2020 and December 31, 2019. Assets are classified in their entirety based on the lowest level of input that is significant to the fair value measurement.


	Fair Value Measurements as of
	June 30, 2020
	Estimated Fair Value		Level 1		Level 2		Level 3
Cash equivalents:
Money market funds	$	209,830	$	209,830	$	—	$	—

Total cash equivalents	209,830		209,830		—		—
Investments:


Asset-backed securities	$	6,112	$	—	$	6,112	$	—
U.S. government securities	25,210		25,210		—		—
Total investments	31,322		25,210		6,112		—
Total cash equivalents and investments	$	241,152	$	235,040	$	6,112	$	—

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)


	Fair Value Measurements as of
	December 31, 2019
	Estimated Fair Value		Level 1		Level 2		Level 3
Cash equivalents:
Money market funds	$	18,429	$	18,429	$	—	$	—

Total cash equivalents	18,429		18,429		—		—
Investments:
Commercial paper	$	14,214	$	—	$	14,214	$	—
Corporate bonds	32,485		—		32,485		—
Asset-backed securities	8,100		—		8,100		—
U.S. government securities	78,082		78,082		—		—
Total investments	132,881		78,082		54,799		—
Total cash equivalents and investments	$	151,310	$	96,511	$	54,799	$	—

There were no transfers between levels during the periods ended June 30, 2020 and December 31, 2019.

Concentration of Credit Risk

Financial instruments, which potentially subject us to concentrations of credit risk, consist principally of cash equivalents, investments, and accounts receivable.

Our investment policy limits investments to certain types of debt securities issued by the U.S. government and its agencies, corporations with investment-grade credit ratings, or commercial paper and money market funds issued by the highest quality financial and non-financial companies. We place restrictions on maturities and concentration by type and issuer. We are exposed to credit risk in the event of a default by the issuers of these securities to the extent recorded on the balance sheets. However, as of June 30, 2020 and December 31, 2019, we limited our credit risk associated with cash equivalents by placing investments with banks we believe are highly creditworthy.

We believe that the credit risk in our accounts receivable is mitigated by our credit evaluation process, relatively short collection terms, and dispersion of our customer base. We generally do not require collateral, and losses on accounts receivable have historically been within management's expectations.

Accounts Receivable and Allowance for Expected Credit Losses

Trade accounts receivable are recorded at the invoiced amount and do not bear interest. Customer credit terms are established prior to shipment with the general standard being net 30 days. Collateral or any other security to support payment of these receivables generally is not required.

We recognize expected credit losses on accounts receivable in accordance with Accounting Standards Update ("ASU"), ASU 2016-13, Financial Instruments - Credit Losses ("ASU 2016-13"), which we adopted effective January 1, 2020 using the modified retrospective approach through a cumulative-effect adjustment to retained earnings. The adoption of ASU 2016-13 did not have a material impact on the amount and timing of credit losses recognized in our financial statements.

Each reporting period, we estimate the credit loss related to accounts receivable based on a migration analysis of accounts grouped by individual receivables delinquency status, and apply our historic loss rate adjusted for management's assumption of future market conditions. Any change in the allowance subsequent to the effective date of January 1, 2020 from new receivables acquired, or changes due to credit deterioration on previously existing receivables, is recorded in selling, general and administrative expenses. Write-offs of receivables considered uncollectible, and any related subsequent recoveries of previously written off receivables, are deducted from the

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

allowance. Specific accounts receivable are written-off once a determination is made that the amount is uncollectible. The write-off is recorded in the period in which the account receivable is deemed uncollectible. Recoveries are recognized when received and as a direct credit to earnings or as a reduction to the allowance for credit losses (which would indirectly reduce earnings by decreasing bad debt expense).

Inventories

Inventories are valued at the lower of cost or net realizable value, computed on a first-in, first-out basis and consisted of the following:


	June 30, 2020		December 31, 2019
Raw materials	$	1,070	$	781
Finished goods	8,896		5,053
Total inventories, net of reserves	$	9,966	$	5,834

We regularly review inventory quantities on-hand for excess and obsolete inventory and, when circumstances indicate, incur charges to write down inventories to their net realizable value. The determination of a reserve for excess and obsolete inventory involves management exercising judgment to determine the required reserve, considering future demand, product life cycles, introduction of new products and current market conditions. The reserve for excess and obsolete inventory was less than $0.1 million as of both June 30, 2020 and December 31, 2019.

Property and Equipment

Property and equipment are stated at cost, less accumulated depreciation and amortization and consisted of the following:


	June 30, 2020		December 31, 2019
Computer equipment and software	$	1,306	$	790
Manufacturing equipment	1,319		1,050
Other equipment	96		68
Leasehold improvements	192		192
Construction in process	1,774		1,950
Property and equipment, cost	4,687		4,050
Less: accumulated depreciation and amortization	(1,380)		(1,005)
Property and equipment, net	$	3,307	$	3,045

Depreciation is determined using the straight-line method over the estimated useful lives of the respective assets, generally three to five years. Leasehold improvements are amortized on a straight-line basis over the shorter of their estimated useful lives or the term of the lease. Depreciation and amortization expense was $0.2 million and $0.1 million for three months ended June 30, 2020 and 2019, respectively, and $0.4 million and $0.2 million for the six months ended June 30, 2020 and 2019, respectively.

Impairment of Long-lived Assets

Long-lived assets consist primarily of property and equipment and are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require that an asset be tested for possible impairment, we compare the undiscounted cash flows expected to be generated by the asset to the carrying amount of the asset. If the carrying amount of the asset is not recoverable on an undiscounted cash flow basis, we determine the fair value of the asset and recognize an impairment loss to the extent the carrying amount of the asset exceeds its fair value. We determine fair value using the income approach based on the present value of expected future cash flows or other appropriate measures of estimated fair value. Our

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(Table amounts in thousands, except share and per share amounts)

cash flow assumptions consider historical and forecasted revenue and operating costs and other relevant factors. We did not record any impairment charges on long-lived assets during either of the six months ended June 30, 2020 or 2019.

Accrued Expenses

Accrued expenses consisted of the following:


	June 30, 2020		December 31, 2019
Payroll related	$	6,968	$	10,304
Interest	155		160
Current operating lease liability	338		828
Other accrued expenses	478		1,105
Total accrued expenses	$	7,939	$	12,397

Revenue Recognition

We recognize revenue in accordance with Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers ("ASC 606"). Revenues from product sales are recognized when the customer obtains control of the product, which occurs at a point in time, either upon shipment of the product or receipt of the product, depending on shipment terms. Our standard shipping terms are free on board shipping point, unless the customer requests that control and title to the inventory transfer upon delivery. In those cases where shipping and handling costs are billed to customers, we classify the amounts billed as a component of cost of goods sold.

Revenue is measured as the amount of consideration we expect to receive, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, which is based on the invoiced price, in exchange for transferring products. All revenue is recognized when we satisfy our performance obligations under the contract. The majority of our contracts have a single performance obligation and are short term in nature.

Sales taxes and value added taxes in foreign jurisdictions that are collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold.

Variable consideration related to certain customer sales incentives is estimated based on the amounts expected to be paid based on the agreement with the customer using probability assessments.

We offer customers a limited right of return for our product in case of non-conformity or performance issues. We estimate the amount of our product sales that may be returned by our customers based on historical sales and returns. As our historical product returns to date have been immaterial, we have not recorded a reduction in revenue related to variable consideration for product returns.

See Note 9 for disaggregated revenue by geographic area.

Cost of Goods Sold

Cost of goods sold consists primarily of acquisition costs for the components of the Inspire system, overhead costs, scrap and inventory obsolescence, as well as distribution-related expenses such as logistics and shipping costs, net of costs charged to customers. The overhead costs include the cost of material procurement, depreciation expense for production equipment, warranty replacement costs, and operations supervision and management personnel, including employee compensation, stock-based compensation, supplies, and travel.

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

Research and Development

Research and development expenses consist primarily of product development, clinical and regulatory affairs, quality assurance, consulting services, and other costs associated with products and technologies in development. These expenses include employee compensation, stock-based compensation, supplies, travel, and facility costs. Clinical expenses include clinical trial design, clinical site reimbursement, data management, travel expenses, and the cost of manufacturing products for clinical trials.

Stock-Based Compensation

We maintain an equity incentive plan to provide long-term incentives for eligible employees, consultants, and members of the board of directors. The plan allows for the issuance of non-statutory and incentive stock options to employees and non-statutory stock options to consultants and directors. We also offer an employee stock purchase plan which allows participating employees to purchase shares of our common stock at a discount through payroll deductions.

We recognize equity-based compensation expense for awards of equity instruments to employees and directors based on the grant date fair value of those awards in accordance with ASC Topic 718, Stock Compensation ("ASC 718"). ASC 718 requires all equity-based compensation awards to employees and directors, including grants of restricted shares and stock options, to be recognized as expense in the statements of operations and comprehensive loss based on their grant date fair values. We estimate the fair value of stock options using the Black-Scholes option pricing model. The fair value of each purchase under the employee stock purchase plan is estimated at the beginning of the offering period using the Black-Scholes option pricing model. We have not granted any restricted shares. We have not granted any stock-based awards to our consultants.

The Black-Scholes option pricing model requires the input of certain subjective assumptions, including (i) the expected share price volatility, (ii) the expected term of the award, (iii) the risk-free interest rate and (iv) the expected dividend yield. Due to the lack of a public market for the trading of our common stock and a lack of company-specific historical and implied volatility data, we have based our estimate of expected volatility on the historical volatility of a group of similar companies that are publicly traded. The historical volatility is calculated based on a period of time commensurate with the expected term assumption. The group of representative companies have characteristics similar to us, including stage of product development and focus on the life science industry. We use the simplified method, which is the average of the final vesting tranche date and the contractual term, to calculate the expected term for options granted to employees and directors as we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term. The risk-free interest rate is based on a U.S. government Treasury instrument whose term is consistent with the expected term of the stock options. We use an assumed dividend yield of zero as we have never paid dividends and have no current plans to pay any dividends on our common stock.

We expense the fair value of our equity-based compensation awards granted to employees and directors on a straight-line basis over the associated service period, which is generally the period in which the related services are received. We account for award forfeitures as they occur.

Advertising Expenses

We expense the costs of advertising, including promotional expenses, as incurred. Advertising expenses were $5.0 million and $4.4 million during the three months ended June 30, 2020 and 2019, and $11.4 million and $7.9 million during the six months ended June 30, 2020 and 2019, respectively.

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

Leases

Operating leases are included in operating lease right-of-use ("ROU") assets and current operating lease liabilities in our balance sheets. ROU assets represent our right to use an underlying asset for the lease term and lease liabilities represent our obligation to make lease payments arising from the lease. Operating lease ROU assets and liabilities are recognized at the lease commencement date based on the present value of lease payments over the lease term. In determining the present value of lease payments, we use our incremental borrowing rate based on the information available at the lease commencement date as the rate implicit in the lease is not readily determinable. The determination of our incremental borrowing rate requires management judgment based on information available at lease commencement. The operating lease ROU assets also include adjustments for prepayments, accrued lease payments and exclude lease incentives. Our lease terms may include options to extend or terminate the lease when it is reasonably certain that we will exercise such options. Operating lease cost is recognized on a straight-line basis over the expected lease term. Lease agreements that include lease and non-lease components are accounted for as a single lease component. Lease agreements with a noncancelable term of less than 12 months are not recorded on our balance sheets.

Income Taxes

We account for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates that will be in effect when the differences are expected to reverse. Valuation allowances against deferred tax assets are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized. As we have historically incurred operating losses, we have recorded a full valuation allowance against our net deferred tax assets, and there is no provision for income taxes other than the accrual for uncertain tax benefits. Our policy is to record interest and penalties expense related to uncertain tax positions as other expense in the statements of operations and comprehensive loss.

Comprehensive Loss

Comprehensive loss consists of net loss and changes in unrealized gains and losses due to interest rate fluctuations and other external factors on investments classified as available-for-sale. Accumulated other comprehensive income is presented in the accompanying balance sheets as a component of stockholders' equity.

Loss Per Share

Basic net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and dilutive potential shares of common stock outstanding during the period. Because we have reported a net loss for all periods presented, diluted net loss per share is the same as basic net loss per share for those periods as all potentially dilutive shares consisting of stock options and warrants were antidilutive in those periods.

Recent Accounting Pronouncements

We have reviewed and considered all other recent accounting pronouncements that have not yet been adopted and believe there are none that could potentially have a material impact on our business practices, financial condition, results of operations, or disclosures.

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NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

3. Investments

Our investments are classified as available-for-sale and consist of the following:


	June 30, 2020
			Unrealized
	Cost		Gains		Losses		Fair Value
Short-Term:


Asset-backed securities	$	6,100	$	12	$	—	$	6,112
U.S. government securities	25,068		142		—		25,210
Short-term investments	$	31,168	$	154	$	—	$	31,322


	December 31, 2019
			Unrealized
	Cost		Gains		Losses		Fair Value
Short-Term:
Commercial paper	$	14,214	$	—	$	—	$	14,214
Corporate bonds	26,194		16		(2)		26,208
Asset-backed securities	8,097		5		(1)		8,101
U.S. government securities	78,017		65		—		78,082
Short-term investments	$	126,522	$	86	$	(3)	$	126,605
Long-Term:
Corporate bonds	$	6,258	$	18	$	—	$	6,276
Long-term investments	$	6,258	$	18	$	—	$	6,276

As of June 30, 2020 and December 31, 2019, we had no investments with a contractual maturity of greater than two years. Currently, we do not intend to sell the investments and it is not more likely than not that we will be required to sell the investments before recovery of their amortized cost bases, which may be maturity. We do not consider those investments to be other-than-temporarily impaired at June 30, 2020. At the end of each reporting period, we evaluate potential credit impairment on available-for-sale securities in an unrealized loss position, based on the expected cash flows to be collected and the yield-to-maturity on those securities. Securities with a valuation allowance for expected credit losses and deemed uncollectible are permanently written-down, and a reversal out of the valuation allowance occurs.

4. Leases

Adoption of ASC Topic 842, Leases

On December 31, 2019, we adopted the new accounting standard ASC 842, Leases, which requires lessees to recognize a lease liability and a ROU asset for all leases with lease terms greater than 12 months. We used the effective date of this standard as the date of initial application, with no retrospective adjustments to prior comparative periods. We were an emerging growth company as defined by the JOBS Act until December 31, 2019 and therefore this guidance became effective for us in the Annual Report on Form 10-K for the fiscal year ended December 31, 2019 as we no longer qualify as an emerging growth company as of that date.

The Statement of Cash Flows for the six months ended June 30, 2019 includes non-cash lease expense, which was reclassified to conform to the current presentation.

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NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

Leases Overview

We previously rented approximately 9,500 square feet of office space under an operating lease that expired on March 31, 2019. In September 2018, we entered into a non-cancelable operating lease agreement to sublease approximately 45,000 square feet of office space for our corporate headquarters, which included real estate taxes and operating expenses in the base rent. This lease commenced January 15, 2019 and expires November 30, 2020. We recognized an additional ROU asset and lease liability of $1.8 million each on January 15, 2019.

In May 2019, we entered into a new, non-cancelable operating lease agreement for the same space directly with the landlord. The initial lease term commences on December 1, 2020 and expires May 31, 2028 with an option to renew for one additional period of five years at the then-prevailing market rate. The exercise of the lease renewal option is at our sole discretion and is not expected to be included in the lease term for the calculation of the ROU asset and lease liability when the lease commences on December 1, 2020 as it is not reasonably certain of exercise.

Beginning December 1, 2020, in addition to base rent, we will also pay our proportionate share of the operating expenses, as defined in the lease. These payments will be made monthly, and will be adjusted annually to reflect actual charges incurred for operating expenses, such as common area maintenance, taxes and insurance. In conjunction with this new lease, the landlord agreed to provide Inspire with a $0.6 million rent abatement and a refurbishment allowance in the amount of the cost of any leasehold improvements, not to exceed approximately $1.1 million upon Inspire providing the necessary documentation evidencing the costs of the leasehold improvements that are completed by May 31, 2022. However, the lease allows us to allocate the refurbishment allowance against base rent instead of taking a tenant improvement reimbursement. At this time, we intend to allocate the full amount of the refurbishment allowance against base rent. The total minimum lease payments related to this forward-starting lease is $7.4 million.

The following table presents the lease balances within the balance sheets:


Leases	Classification	June 30, 2020		December 31, 2019
Assets
Operating	Operating lease right-of-use asset	$	424	$	915
Liabilities
Operating	Accrued expenses	$	338	$	828

As of June 30, 2020, the remaining lease term was 0.4 years and the discount rate was 8.0%. The operating cash outflows from our operating leases were $0.2 million and $0.3 million, for the three months ended June 30, 2020 and 2019, respectively, and $0.5 million for each of the six months ended June 30, 2020 and 2019.

5. Long-Term Debt

In August 2015, we entered into a loan and security agreement that initially provided for a term A loan facility in the amount of $15.5 million, which was fully funded on the closing date, and a term B loan facility in an amount between $3.5 million and $10.0 million, subject to our achievement of certain revenue milestones. We refer to our term A loan facility and our term loan B facility together as our credit facility. In February 2017, we amended the loan and security agreement to, among other things, increase borrowings under the term A loan facility by $1.0 million, for a total of $16.5 million outstanding under the credit facility, and reduced borrowings available under the term B loan facility to $9.0 million.

On March 27, 2019, we amended the loan and security agreement. The amendment modified the terms of the loan and security agreement to: (1) extend the interest-only date from March 1, 2020 to April 1, 2022 and extend the maturity date from February 1, 2022 to March 1, 2024; (2) reduce the final payment percentage from 5.50% to 3.50%; (3) modify the basic rate to be a per annum rate of interest (based on a year of 360 days) equal to the sum

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NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

of (i) the greater of (A) the 30 day U.S. LIBOR rate reported in The Wall Street Journal on the last business day of the month that immediately precedes the month in which the interest will accrue or (B) 2.50%, plus (ii) 5.10%; provided, however, under no circumstances will the basic rate be less than 7.60%; (4) provide a mechanism for determining an alternative interest rate to replace the U.S. LIBOR rate upon the occurrence of certain circumstances; and (5) revise the prepayment fee to be between 1.00% and 3.00% of the principal amount, depending on the timing of any prepayment. Upon closing the amendment to the loan and security agreement, payment of the previously accrued final payment under the credit facility was required.

In addition to the principal and interest payments, under the credit facility, we are required to pay a final payment fee of 3.50% on all amounts outstanding, which is being accreted using the effective interest rate method over the term of the loan and security agreement and shall be due at the earlier of maturity or prepayment. Borrowings are prepayable at our option in whole, but not in part, together with all accrued and unpaid interest thereon and, if not previously made, the final payment, subject to a prepayment fee of 2.00% if such borrowings are prepaid prior to March 27, 2021 and 1.00% if such borrowings are prepaid on or after March 27, 2021.

The credit facility includes affirmative and restrictive covenants and events of default, including the following events of default: payment defaults, breaches of covenants, judgment defaults, cross defaults to certain other contracts, certain events with respect to governmental approvals if such events could cause a material adverse change, a material impairment in the perfection or priority of the lender's security interest or in the value of the collateral, a material adverse change in the business, operations, or condition of us or any of our subsidiaries, and a material impairment of the prospect of repayment of the loans. Upon the occurrence of an event of default, a default increase in the interest rate of an additional 5.00% could be applied to the outstanding loan balance and the lender could declare all outstanding obligations immediately due and payable and take such other actions as set forth in the loan and security agreement.

Our obligations under the credit facility are secured by a first priority security interest in substantially all of our assets, other than our intellectual property. There are no financial covenants contained in the loan and security agreement. We were in compliance with the affirmative and restrictive covenants as of June 30, 2020.

Expected future principal payments for the credit facility are as follows:


Year ending December 31:
2020 (remaining)	$	—
2021	—
2022	9,188
2023	12,250
2024	3,062
Total expected future principal payments	$	24,500

6. Employee Retirement Plan

We sponsor an employee retirement plan covering all of our full-time employees. The plan allows for eligible employees to defer a portion of their eligible compensation up to the maximum allowed by IRS Regulations. We may elect to make a voluntary contribution to the plan. We have not made contributions since inception.

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

7. Stock-Based Compensation

Stock Options

We adopted the 2007 Stock Incentive Plan (the "2007 Plan") in November 2007, which terminated in accordance with its terms on November 28, 2017; however, the outstanding stock options may continue to be exercised in accordance with their terms.

Immediately following the termination of the 2007 Plan, we adopted the 2017 Stock Incentive Plan (the "2017 Plan"), which contains substantially similar terms and conditions as the 2007 Plan. Upon the IPO, no further grants were made under the 2017 Plan and we adopted the 2018 Stock Incentive Plan (the "2018 Plan"). The purpose of the 2018 Plan is to promote the interest of our company and our stockholders by aiding in attracting and retaining employees, officers, consultants, contractors, and directors capable of assuring the future success of our business and to afford such persons an opportunity to acquire a proprietary interest in our company. The board of directors may amend, alter, suspend, discontinue, or terminate the 2018 Plan at any time with the approval of our stockholders. A total of 1,386,809 shares of common stock were initially reserved for issuance under the 2018 Plan, and this share reserve will automatically be supplemented each January 1, commencing on January 1, 2019 and ending on and including January 1, 2028, by an amount of shares equal to the lesser of: a) 739,631 shares, b) 4% of the shares outstanding on the final day of the immediately preceding fiscal year and c) such smaller number of shares as determined by the board of directors.

As of June 30, 2020, there were 2,837,031 shares reserved for issuance under the 2018 Plan, of which 1,156,343 shares were available for issuance. Prior to the IPO, the exercise price of stock options represented fair value of the common stock at the time of issuance and was determined by the board of directors with the assistance of a third-party valuation specialist. Post-IPO, options are granted at the exercise price, which is equal to the closing price of our stock on the date of grant. The stock options granted to employees include a four-year service period and 25% vest after the first year of service and the remainder vest in equal installments over the next 36 months of service. The stock options granted to the board of directors vest in one, two or three equal annual installments, in each case, subject to the director's continuous service through the applicable vesting date. The stock options have a contractual life of ten years.

A summary of stock option activity and related information is as follows:


	Options	Weighted Average Exercise Price				Weighted average remaining contractual term (years)		Aggregate intrinsic value (in thousands)
Outstanding at December 31, 2019	2,844,164		$	30.41	7.9	$	124,585
Granted	172,331		$	77.12
Exercised	(324,995)		$	4.67		$	18,795
Forfeited	(42,279)		$	36.03
Outstanding at June 30, 2020	2,649,221		$	36.51	7.8	$	133,806
Exercisable at June 30, 2020	1,132,084		$	13.79	6.3	$	82,906

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

Total stock-based compensation recognized, before taxes, during the three and six months ended June 30, 2020 and 2019, is as follows:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2020		2019		2020		2019
Cost of goods sold	$	33	$	26	$	86	$	52
Research and development	372		161		717		324
Selling, general and administrative	2,498		1,202		4,849		2,404
Total stock-based compensation	$	2,903	$	1,389	$	5,652	$	2,780

As of June 30, 2020, the amount of unearned stock-based compensation currently estimated to be expensed from now through the year 2024 related to unvested employee and non-employee director stock-based awards is $33.9 million, and the weighted average period over which the unearned stock-based compensation is expected to be recognized is 2.8 years. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase, or cancel any remaining unearned stock compensation expense. Future stock-based compensation expense and unearned stock-based compensation will increase to the extent that we grant additional stock-based awards.

We estimate the fair value of stock-based awards on the date of grant using the Black-Scholes option pricing model using the fair market value of our common stock on the date of grant and a number of other complex and subjective assumptions. These assumptions include, but are not limited to, estimates regarding the expected term of the awards, estimates of the stock volatility over a duration that approximates the expected term of the awards, estimates of the risk-free rate, and estimates of expected dividend rates.

Due to our limited amount of historical exercise, forfeiture, and expiration activity, we have opted to use the "simplified method" for estimating the expected term of options, whereby the expected term equals the arithmetic average of the vesting terms and the original contractual term of the option. We will continue to analyze our expected term assumption as more historical data becomes available. Due to our limited operating history and a lack of company specific historical and implied volatility data, we have based our estimate of expected volatility on the historical volatility of a group of similar companies that are publicly traded. When selecting these public companies on which we have based our expected stock price volatility, we generally selected companies with comparable characteristics to it, including enterprise value, stages of clinical development, risk profiles, position within the industry, and with historical share price information sufficient to meet the expected life of the stock-based awards. The historical volatility data was computed using the weekly closing prices for the selected companies' shares over historical periods that approximate calculated expected term of our stock-based awards. We will continue to analyze the historical stock price volatility assumption as more historical data for our common stock becomes available.

The risk-free rate assumption is based on the U.S. government Treasury instruments with maturities similar to the expected term of our stock options.

The expected dividend assumption is based on our history of not paying dividends and our expectation that we will not declare dividends for the foreseeable future.

The amount of stock-based compensation expense is recognized on a straight-line basis over the vesting term and is reduced by actual forfeitures as they occur.

The fair value of options granted to employees and non-employee directors during the six months ended June 30, 2020 and 2019 was estimated as of the grant date using the Black-Scholes option pricing model using the following assumptions:

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NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)


	Six Months Ended
	June 30,
	2020	2019
Expected life (years)	5.50 - 6.25	5.50 - 6.25
Expected volatility	42.3 - 49.3%	47.7 - 50.6%
Risk-free interest rate	0.36 - 1.42%	1.87 - 2.63%
Dividend yield	0.0%	0.0%
Weighted average fair value	$35.10	$26.55

Employee Stock Purchase Plan

Our employee stock purchase plan (“ESPP”) allows participating employees to purchase shares of our common stock at a discount through payroll deductions. The plan is available to all of our U.S.-based full-time employees. Participating employees may purchase common stock, on a voluntary after-tax basis, at a price equal to 85% of the lower of the closing market price per share of our common stock on the first or last trading day of each stock purchase period. The plan provides for six-month purchase periods, beginning on January 1 and July 1 of each calendar year.

A total of 277,362 shares of common stock were initially reserved for issuance under the ESPP, and this share reserve will automatically be supplemented each January 1, commencing on January 1, 2019 and ending on and including January 1, 2028, by an amount of shares equal to the lesser of: a) 184,908 shares, b) 1% of the shares outstanding on the final day of the immediately preceding calendar year and c) such smaller number of shares as the board of directors may determine. On June 30, 2020, 16,730 shares were purchased under the ESPP, utilizing $1.1 million of employee contributions. As of June 30, 2020, 598,698 shares were available for future issuance under the ESPP. The current purchase period under the ESPP began on July 1, 2020 and ends December 31, 2020. We recognized stock-based compensation expense associated with the ESPP of $0.2 million and $0.1 million for the three months ended June 30, 2020 and 2019, respectively, and $0.3 million and $0.2 million for the six months ended June 30, 2020 and 2019, respectively.

8. Income Taxes

During the three and six months ended June 30, 2020 and 2019, we did not record an income tax benefit related to our loss before income taxes in the statement of operations and comprehensive loss because a valuation allowance has been required to be established for all deferred tax assets due to our cumulative net loss position.

As of December 31, 2019, our gross federal net operating loss carryforwards of $160.9 million will expire at various dates beginning in 2028. In addition, net operating loss carryforwards for state income tax purposes of $347.1 million that include net operating losses that will begin to expire in 2028. We also have gross research and development credit carryforwards of $2.5 million as of December 31, 2019, which will expire at various dates beginning in 2033.

Utilization of the net operating loss carryforwards may be subject to an annual limitation due to the ownership change limitations provided by Section 382 of the Internal Revenue Code of 1986 and similar state provisions. We have not performed a detailed analysis to determine whether an ownership change has occurred. Such a change of ownership would limit our utilization of the net operating losses and could be triggered by subsequent sales of securities by us or our stockholders.

Realization of the deferred tax assets is dependent upon the generation of future taxable income, if any, the amount and timing of which are uncertain. Based on available objective evidence and cumulative losses, we believe it is more likely than not that the deferred tax assets are not recognizable and will not be recognizable until we have sufficient taxable income. Accordingly, the net deferred tax assets have been fully offset by a valuation allowance.

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INSPIRE MEDICAL SYSTEMS, INC.

NOTES TO FINANCIAL STATEMENTS (Unaudited)

(Table amounts in thousands, except share and per share amounts)

We had less than $0.1 million of gross unrecognized tax benefits as of June 30, 2020 and December 31, 2019.

We file income tax returns in the applicable jurisdictions. The 2015 to 2018 tax years remain open to examination by the major taxing authorities to which we are subject. We do not expect a significant change to our unrecognized tax benefits over the next 12 months.

9. Segment Reporting and Revenue Disaggregation

We operate our business as one reporting segment. An operating segment is defined as a component of an enterprise for which separate discrete financial information is available and evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. Segment information is consistent with how management reviews the business, makes investing and resource allocation decisions and assesses operating performance.

We sell our Inspire system to hospitals and ambulatory surgery centers in the U.S. and in select countries in Europe through a direct sales organization. Revenue by geographic region is as follows:


	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2020		2019		2020		2019
United States	$	10,984	$	15,754	$	30,258	$	30,109
Europe	1,199		2,278		3,272		4,173
Total revenue	$	12,183	$	18,032	$	33,530	$	34,282

All of our long-lived assets are located in the U.S.

10. Loss Per Share

Basic net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock outstanding during the period. Diluted net loss per share is computed by dividing the net loss by the weighted average number of shares of common stock and dilutive potential shares of common stock outstanding during the period. Because we have reported a net loss for all periods presented, diluted net loss per share is the same as basic net loss per share for those periods as all potentially dilutive shares consisting of common stock warrants and common stock options were antidilutive in those periods.

The following potentially dilutive securities outstanding at the end of the periods presented have been excluded from the computations of diluted shares outstanding because such securities have an antidilutive impact due to losses reported:


	June 30,
	2020	2019
Common stock warrants	—	6,595
Common stock options outstanding	2,649,221	2,365,059
Total	2,649,221	2,371,654

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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes to those statements included elsewhere in this Quarterly Report on Form 10-Q, as well as the audited financial statements and the related notes thereto, and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, such as information with respect to our plans and strategy for our business and the impact of the ongoing and global COVID-19 pandemic on our business, financial results and financial condition on our business, financial results and financial condition includes forward-looking statements that involve risks and uncertainties. As a result of many important factors, including those set forth in the "Risk Factors" sections of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 and this Quarterly Report on Form 10-Q, our actual results could differ materially from the results described in, or implied, by these forward-looking statements.

Overview

We are a medical technology company focused on the development and commercialization of innovative and minimally invasive solutions for patients with obstructive sleep apnea ("OSA"). Our proprietary Inspire system is the first and only FDA-approved neurostimulation technology that provides a safe and effective treatment for moderate to severe OSA. We have developed a novel, closed-loop solution that continuously monitors a patient’s breathing and delivers mild hypoglossal nerve stimulation to maintain an open airway. Inspire therapy is indicated for patients with moderate to severe OSA who do not have significant central sleep apnea and do not have a complete concentric collapse of the airway at the soft palate level. In addition, patients in the U.S. must have been confirmed to fail or be unable to tolerate positive airway pressure treatments, such as CPAP, and be 18 years of age or older, though there are no similar requirements for patients in Europe.

We sell our Inspire system to hospitals and ambulatory surgery centers ("ASCs") in the U.S. and in select countries in Europe through a direct sales organization. Our direct sales force engages in sales efforts and promotional activities focused on ear, nose and throat ("ENT") physicians and sleep centers. In addition, we highlight our compelling clinical data and value proposition to increase awareness and adoption amongst referring physicians. We build upon this top-down approach with strong direct-to-patient marketing initiatives to create awareness of the benefits of our Inspire system and drive demand through patient empowerment. This outreach helps to educate thousands of patients on our Inspire therapy and frequently results in patient leads.

Although our sales and marketing efforts are directed at patients and physicians because they are the primary users of our technology, we consider the hospitals and ASCs where the procedure is performed to be our customers, as they are the purchasing agents of our Inspire system. Our customers are reimbursed the cost required to treat each patient through various third-party payors, such as commercial payors and government agencies. Our Inspire system is currently reimbursed primarily on a per-patient prior authorization basis for patients covered by commercial payors, on a case-by-case basis for patients covered by Medicare, and under U.S. government contract for patients who are treated by the Veterans Health Administration. As of August 4, 2020, we have secured positive coverage policies with 56 U.S. commercial payors, including most large national commercial insurers, covering approximately 182 million lives in the U.S. In addition, all seven Medicare Administrative Contractors ("MACs") published final policies in 2020 covering Inspire therapy. Each MAC also assigned a surgeon reimbursement of approximately $450 for the procedure to implant the pressure sensor (add-on CPT code +0466T). In June 2018, Japan’s Ministry of Health, Labour and Welfare approved our Inspire therapy to treat moderate to severe OSA, and we are currently seeking reimbursement coverage in Japan. For the six months ended June 30, 2020, 90.2% of our revenue was derived in the U.S. and 9.8% was derived in Europe. No single customer accounted for more than 10% of our revenue during the six months ended June 30, 2020.

Our patient engagement efforts continue to include our refocused direct-to-consumer marketing strategies, which, during the six months ended June 30, 2020, initially included a shift from radio and TV in our larger markets that were affected by COVID-19 towards more digital and TV in smaller markets. During the second quarter of 2020, we

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resumed radio and TV initiatives in our larger markets as the impact of COVID-19 lessened in those areas. Further, our team has leveraged virtual tools, such as the new Inspire Sleep app released during the second quarter of 2020, and telemedicine to continue physician training and patient education.

We rely on third-party suppliers to manufacture our Inspire system and its components. Many of these suppliers are currently single source suppliers. We seek to maintain higher levels of inventory to protect ourselves from supply interruptions, and, as a result, we are subject to the risk of inventory obsolescence and expiration, which could lead to inventory impairment charges. In the U.S., our products are shipped directly to our customers on a purchase order basis, primarily by a third-party vendor with a facility in Tennessee, although we do ship some products from our facility in Minnesota. Warehousing and shipping operations for our European customers are handled by a third-party vendor with a facility located in the Netherlands. Customers do not have the right to return non-defective product, nor do we place product on consignment. Our sales representatives do not maintain trunk stock.

Since our inception in 2007, we have financed our operations primarily through sales of our Inspire system, private placements of our convertible preferred securities, amounts borrowed under our credit facility, the initial public offering of our common stock that closed in May 2018 (our "IPO") and the offerings of our common stock that closed in December 2018 and April 2020 (our "follow-on offerings"). We have devoted significant resources to research and development activities related to our Inspire system, including clinical and regulatory initiatives to obtain marketing approval, and sales and marketing activities. For the three months ended June 30, 2020, we generated revenue of $12.2 million with a gross margin of 84.0% and had a net loss of $23.1 million compared to revenue of $18.0 million with a gross margin of 82.8% and a net loss of $7.7 million for the three months ended June 30, 2019. For the six months ended June 30, 2020, we generated revenue of $33.5 million with a gross margin of 84.3% and had a net loss of $39.3 million compared to revenue of $34.3 million with a gross margin of 82.6% and a net loss of $15.9 million for the six months ended June 30, 2019. Our accumulated deficit as of June 30, 2020 was $219.5 million.

We have invested heavily in product development. Our research and development activities have been centered on driving continuous improvements to our Inspire therapy. We have also made significant investments in clinical studies to demonstrate the safety and efficacy of our Inspire therapy and to support regulatory submissions. We also continue to make significant investments building our sales and marketing organization by increasing the number of U.S. sales representatives and continuing our direct-to-patient marketing efforts in existing and new markets throughout the U.S. and in Europe. In the three months ended June 30, 2020, we continued to train new U.S. medical centers and activated 16 centers, and deactivated 15 then-existing centers that no longer implant Inspire therapy, bringing the total to 328 U.S. medical centers implanting Inspire therapy as of June 30, 2020. During the COVID-19 pandemic business slowdown in the second quarter of 2020, we conducted a thorough review of all centers and deactivated centers for reasons such as surgeons relocating their implanting locations as well as where the location no longer implants Inspire therapy. Additionally, we created nine new territories during the three months ended June 30, 2020, bringing the total to 91 U.S. territories as of June 30, 2020. We continue to make investments in research and development efforts to develop our next generation Inspire systems and support our future regulatory submissions for expanded indications and for new markets such as Europe, Japan, and Australia. For example, in April 2020, we received FDA approval for an expanded age-range for Inspire therapy to include 18 to 21 year old patients. Because of these and other factors, we expect to continue to incur net losses for the next several years, and we expect to require substantial additional funding, which may include future equity and debt financings.

Outlook

We expect the COVID-19 pandemic to continue to adversely impact our revenue due to the significant decreases and delays in the number of Inspire therapy procedures performed and patients screened for eligibility for Inspire therapy. Beginning in the second week of March 2020, substantially all of the scheduled Inspire therapy procedures were postponed and numerous other authorized cases were unable to be scheduled. During April 2020, the widespread shutdown in elective surgical procedures continued, with surgical volumes increasing in May and even

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further in June, yet still remaining below pre-COVID-19 levels. The resurgence of COVID-19 in various U.S. regions has, and will likely continue to, adversely impact our procedure volumes. A portion of the second quarter 2020 procedures performed were those rescheduled from March 2020, however, a backlog continues to grow into the second half of 2020. Once the pandemic subsides, we anticipate that there will be a substantial backlog of patients seeking appointments with physicians and surgeries to be performed at hospitals and ambulatory surgery centers relating to a variety of medical conditions and that patients seeking Inspire therapy procedures may have to navigate limited provider, hospital and ambulatory surgery center capacity.

In response to the spread of COVID-19 and in line with recommendations from federal and local government and healthcare agencies, we transitioned employees, except for those deemed essential to key aspects of our business, to a remote work environment. Beginning in May 2020, our corporate office re-opened with strict sanitation and physical distancing protocols, although many corporate employees continue to work remotely as a heightened precautionary measure. Additionally, our field staff continues to primarily work remotely and must adhere to the respective hospital's and ambulatory surgery center's COVID-19 protocols when visiting centers. During the period during which surgical procedures have been, and continue to be significantly limited, we identified and implemented innovative solutions to support patients who have Inspire therapy, as well as continuing to educate patients who may be struggling with their sleep apnea. Patients continue to reach out to learn more about the therapy and get connected to a healthcare provider, and we are supporting this interaction through the use of several virtual tools, including the new Inspire Sleep app, and telemedicine. We are also not expecting any material changes to our headcount and are continuing with our planned expansion in recruiting Territory Managers, though we have slightly reduced our hiring initiatives for sales support roles.

To date, we have not experienced disruptions to our supply chain network as a result of the COVID-19 pandemic. We have also not reduced our capital expenditures and are continuing to invest in research and development, however, we may determine to allocate resources differently due to impacts of the COVID-19 pandemic.

Notwithstanding our expected reduced revenue, we believe that our existing cash resources will be sufficient to meet our capital requirements and fund our operations for at least the next 12 months. For additional information, see “— Liquidity and Capital Resources.”

Components of Our Results of Operations

Revenue

We derive primarily all of our revenue from the sale of our Inspire system to hospitals and ambulatory surgery centers in the U.S. and select countries in Europe. We recognize revenues from sales of our Inspire system when the customer obtains control of the product, which occurs at a point in time, either upon shipment of the product or receipt of the product, depending on shipment terms.

Our revenue has fluctuated, and may continue to fluctuate, from quarter to quarter due to a variety of factors. For example, we have historically experienced seasonality in our first and fourth quarters and have experienced adverse impacts on our revenue due to the COVID-19 pandemic.

Revenue for the three and six months ended June 30, 2020 was negatively impacted due to the global pandemic associated with COVID-19. Specifically, in March 2020, healthcare facilities and clinics began restricting access to their clinicians, reducing patient consultations and treatments or temporarily closing their facilities. As a result, beginning in the second week of March 2020, substantially all of our then-scheduled Inspire therapy procedures were postponed, and numerous other cases with prior authorization could not be scheduled and were, therefore, also postponed. During April 2020, the widespread shutdown in elective surgical procedures continued, with surgical volumes increasing in May and even further in June, yet still remaining below pre-COVID-19 levels. A portion of the second quarter 2020 procedures performed were rescheduled from March 2020, however, a backlog continues to grow into the second half of 2020.

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Cost of Goods Sold and Gross Margin

Cost of goods sold consists primarily of acquisition costs for the components of the Inspire system, overhead costs, scrap, and inventory obsolescence, as well as distribution-related expenses such as logistics and shipping costs, net of costs charged to customers. The overhead costs include the cost of material procurement, depreciation expense for production equipment, warranty replacement costs, and operations supervision and management personnel, including employee compensation, stock-based compensation, supplies, and travel. We expect cost of goods sold to increase or decrease in absolute dollars primarily as, and to the extent, our revenue grows or declines, respectively.

We calculate gross margin as gross profit divided by revenue. Our gross margin has been and we expect it will continue to be affected by a variety of factors, including manufacturing costs, the average selling price of our Inspire system, the implementation of cost-reduction strategies, inventory obsolescence costs, which generally occur when new generations of our Inspire system are introduced, and to a lesser extent the sales mix between the U.S. and Europe as our average selling price in the U.S. tends to be higher than in Europe. Our gross margin may increase over the long term to the extent our production volumes increase and we receive discounts on the costs charged by our contract manufacturers, thereby reducing our per unit costs. However, our gross margin may fluctuate from quarter to quarter due to seasonality.

Research and Development Expenses

Research and development expenses consist primarily of product development, engineering, clinical studies to develop and support our products, regulatory expenses, quality assurance, testing, consulting services and other costs associated with the next generation versions of the Inspire system. These expenses include employee compensation, including stock-based compensation, supplies, materials, consulting, and travel expenses related to research and development programs. Additionally, these expenses include clinical trial management, payments to clinical investigators, data management and travel expenses for our various clinical trials. We expect research and development expenses to increase in the future as we develop next generation versions of our Inspire system and continue to expand our clinical studies to secure positive coverage policies from private commercial payors in the U.S. and enter into new markets including additional European countries, Japan, and Australia. We expect research and development expenses as a percentage of revenue to vary over time depending on the level and timing of initiating new product development efforts and new clinical development activities.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of compensation for personnel, including base salaries, stock-based compensation expense and commissions related to our sales organization, finance, information technology, and human resource functions, as well as spending related to marketing, sales operations, and training and reimbursement personnel. Other selling, general and administrative expenses include training physicians, travel expenses, advertising, direct-to-patient promotional programs, conferences, trade shows and consulting services, professional services fees, audit fees, insurance costs and general corporate expenses, including facilities-related expenses.

Other (Income) Expense, Net

Other (income) expense, net consists primarily of interest expense payable under our credit facility and interest income.

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Results of Operations


	Three Months Ended														Six Months Ended
	June 30,														June 30,
	2020		2019		$ Change		% Change		2020		2019		$ Change		% Change
	(in thousands, except percentages)
Revenue	$	12,183	$	18,032	$	(5,849)	(32.4)	%	$	33,530	$	34,282	$	(752)	(2.2)	%
Cost of goods sold	1,954		3,094		(1,140)		(36.8)	%	5,251		5,948		(697)		(11.7)	%
Gross profit	10,229		14,938		(4,709)		(31.5)	%	28,279		28,334		(55)		(0.2)	%
Gross margin	84.0%		82.8%						84.3%		82.6%
Operating expenses:
Research and development	6,062		2,846		3,216		113.0	%	11,500		5,449		6,051		111.0	%
Selling, general and administrative	26,981		20,268		6,713		33.1	%	56,033		39,838		16,195		40.7	%
Total operating expenses	33,043		23,114		9,929		43.0	%	67,533		45,287		22,246		49.1	%
Operating loss	(22,814)		(8,176)		(14,638)		179.0	%	(39,254)		(16,953)		(22,301)		131.5	%
Other expense (income), net	275		(526)		801		(152.3)	%	80		(1,037)		1,117		(107.7)	%
Net loss	$	(23,089)	$	(7,650)	$	(15,439)	201.8	%	$	(39,334)	$	(15,916)	$	(23,418)	147.1	%

Comparison of the Three Months Ended June 30, 2020 and 2019

Revenue

Revenue decreased $5.8 million, or 32.4%, to $12.2 million for the three months ended June 30, 2020 compared to $18.0 million for the three months ended June 30, 2019. The decrease was attributable to a $4.8 million decrease in sales of our Inspire system in the U.S. and a decrease of $1.1 million in Europe, primarily in Germany. Beginning in March 2020, our revenue growth in the U.S. and Europe was impacted by the COVID-19 pandemic, which disrupted our ability to access our clinician customers and their patients. Specifically, we saw healthcare facilities and clinics restricting access to their clinicians, reducing patient consultations and treatments, or closing temporarily due to COVID-19. As a result, beginning in the second week of March 2020, substantially all of our Inspire therapy procedures were postponed and numerous other cases, which had received prior authorization, were not able to be scheduled and, therefore were also postponed. During April 2020, the widespread shutdown in elective surgical procedures continued, with surgical volumes increasing in May and even further in June, yet still remaining below pre-COVID-19 levels.

Revenue information by region is summarized as follows:


	Three Months Ended June 30,
	2020						2019						Change
	Amount		% of Revenue		Amount		% of Revenue		$		%
	(in thousands, except percentages)
United States	$	10,984	90.2	%	$	15,754	87.4	%	$	(4,770)	(30.3)	%
Europe	1,199		9.8	%	2,278		12.6	%	(1,079)		(47.4)	%
Total revenue	$	12,183	100.0	%	$	18,032	100.0	%	$	(5,849)	(32.4)	%

Revenue generated in the U.S. was $11.0 million for the three months ended June 30, 2020, a decrease of $4.8 million, or 30.3%, compared to the three months ended June 30, 2019. The revenue decline in the U.S. was primarily due to impacts from the COVID-19 pandemic.

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Revenue generated in Europe was $1.2 million in the three months ended June 30, 2020, a decrease of $1.1 million, or 47.4%, compared to the three months ended June 30, 2019. The revenue decline in Europe was primarily due to impacts from the COVID-19 pandemic.

Cost of Goods Sold and Gross Margin

Cost of goods sold decreased $1.1 million, or 36.8%, to $2.0 million for the three months ended June 30, 2020 compared to $3.1 million for the three months ended June 30, 2019. The decrease was primarily due to lower sales volume of our Inspire system.

Gross margin increased to 84.0% for the three months ended June 30, 2020 compared to 82.8% for the three months ended June 30, 2019. Gross margin for the three months ended June 30, 2020 was higher primarily due to manufacturing efficiencies.

Research and Development Expenses

Research and development expenses increased $3.3 million, or 113.0%, to $6.1 million for the three months ended June 30, 2020 compared to $2.8 million for the three months ended June 30, 2019. This change was primarily due to an increase of $2.5 million for ongoing research and development costs, including ongoing development of the next generation Inspire therapy system and $0.6 million of compensation and employee-related expenses, mainly as a result of increased headcount, and $0.2 million of regulatory submissions and clinical studies expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $6.7 million, or 33.1%, to $27.0 million for the three months ended June 30, 2020 compared to $20.3 million for the three months ended June 30, 2019. The primary driver of this increase was an increase of $6.5 million in compensation, including salaries, commissions, and stock-based compensation, and other employee-related expenses, mainly as a result of increased headcount, offset by a decrease of $1.3 million of travel expenses not incurred due to the COVID-19 pandemic. In addition, marketing expenses increased $1.0 million, primarily consisting of direct-to-patient initiatives, including TV advertisements which began airing in the second half of 2019. During the three months ended June 30, 2020, we continued to leverage virtual tools, including the new Inspire Sleep app released in the second quarter of 2020, and telemedicine to continue physician training and patient education. Other drivers of the increase to selling, general and administrative expenses included an increase of $0.5 million due to insurance costs, financial audit fees, consulting fees and information technology supplies and equipment.

Other (Income) Expense, Net

Other (income) expense, net decreased by $0.8 million, or 152.3%, to $0.3 million of expense, net for the three months ended June 30, 2020 compared to $0.5 million of income for the three months ended June 30, 2019. This change was primarily due to a decrease in interest income of $0.8 million earned on our cash, cash equivalents and investments balances due to lower interest rates.

Comparison of the Six Months Ended June 30, 2020 and 2019

Revenue

Revenue decreased $0.8 million, or 2.2%, to $33.5 million for the six months ended June 30, 2020 compared to $34.3 million for the six months ended June 30, 2019. The net decrease was attributable to a decrease of $0.9 million in Europe, primarily in Germany, partially offset by a $0.1 million increase in sales of our Inspire system in the U.S. Beginning in March 2020, our revenue growth in the U.S. and Europe was impacted by the COVID-19 pandemic, which disrupted our ability to access our clinician customers and their patients. Specifically, we saw healthcare facilities and clinics restricting access to their clinicians, reducing patient consultations and treatments, or closing temporarily due to COVID-19. As a result, beginning in the second week of March 2020, substantially all of

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our Inspire therapy procedures were postponed and numerous other cases, which had received prior authorization, were not able to be scheduled and, therefore were also postponed. During April 2020, the widespread shutdown in elective surgical procedures continued, with surgical volumes increasing in May and even further in June, yet still remaining below pre-COVID-19 levels.

Revenue information by region is summarized as follows:


	Six Months Ended June 30,
	2020						2019						Change
	Amount		% of Revenue		Amount		% of Revenue		$		%
	(in thousands, except percentages)
United States	$	30,258	90.2	%	$	30,109	87.8	%	$	149	0.5	%
Europe	3,272		9.8	%	4,173		12.2	%	(901)		(21.6)	%
Total revenue	$	33,530	100.0	%	$	34,282	100.0	%	$	(752)	(2.2)	%

Revenue generated in the U.S. was $30.3 million for the six months ended June 30, 2020, an increase of $0.1 million, or 0.5%, compared to the six months ended June 30, 2019. Revenue growth in the U.S. was due to increased market penetration in existing territories, the expansion into new territories, increased physician and patient awareness of our Inspire system, a greater number of prior authorization approvals, additional positive coverage policies and, to a lesser extent, an increase in our average selling price as a result of the introduction of the new sensing lead on the Inspire system to the U.S. market in February 2019. As noted above, U.S. revenue for the six months ended June 30, 2020 was negatively impacted by the COVID-19 pandemic.

Revenue generated in Europe was $3.3 million in the six months ended June 30, 2020, a decrease of $0.9 million, or 21.6%, compared to the six months ended June 30, 2019. The revenue decline in Europe was due to impacts from the COVID-19 pandemic.

Cost of Goods Sold and Gross Margin

Cost of goods sold decreased $0.6 million, or 11.7%, to $5.3 million for the six months ended June 30, 2020 compared to $5.9 million for the six months ended June 30, 2019. The decrease was primarily due to lower sales volume of our Inspire system.

Gross margin increased to 84.3% for the six months ended June 30, 2020 compared to 82.6% for the six months ended June 30, 2019. Gross margin for the six months ended June 30, 2020 was higher primarily due to manufacturing efficiencies.

Research and Development Expenses

Research and development expenses increased $6.1 million, or 111.0%, to $11.5 million for the six months ended June 30, 2020 compared to $5.4 million for the six months ended June 30, 2019. This change was primarily due to an increase of $4.6 million for ongoing research and development costs, including ongoing development of the next generation Inspire therapy system, $1.3 million of compensation and employee-related expenses, mainly as a result of increased headcount, and $0.2 million of regulatory submissions and clinical studies expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses increased $16.2 million, or 40.7%, to $56.0 million for the six months ended June 30, 2020 compared to $39.8 million for the six months ended June 30, 2019. The primary driver of this increase was an increase of $12.1 million in compensation, including salaries, commissions, and stock-based compensation, and other employee-related expenses, mainly as a result of increased headcount, offset by a decrease of $1.1 million of travel expenses not incurred due to the COVID-19 pandemic. In addition, marketing expenses increased $4.2 million, primarily consisting of direct-to-patient initiatives, including TV advertisements which began airing in the second half of 2019. During the six months ended June 30, 2020, we initially refocused

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our direct-to-consumer marketing strategies by shifting from radio and TV in our larger markets that were affected by COVID-19 towards more digital and TV in smaller markets. During the second quarter of 2020, we resumed radio and TV initiatives in our larger markets as the impact of COVID-19 lessened in those areas. Further, our team leveraged virtual tools, including the new Inspire Sleep app released in the second quarter of 2020, and telemedicine to continue physician training and patient education. Other drivers of the increase to selling, general and administrative expenses included an increase of $0.9 million due to insurance costs, financial audit fees, consulting fees and information technology supplies and equipment.

Other (Income) Expense, Net

Other (income) expense, net decreased by $1.1 million, or 107.7%, to $0.1 million of expense, net for the six months ended June 30, 2020 compared to $1.0 million of income for the six months ended June 30, 2019. This change was primarily due to a decrease of $1.2 million in interest income due to lower interest rates on our cash, cash equivalents and investments balances, partially offset by a $0.1 million increase in unrealized gain on investments.

Seasonality

Historically, we have experienced seasonality in our first and fourth quarters, and we expect this trend to continue. In the U.S., we have experienced, and may in the future experience, higher sales in the fourth quarter as a result of patients having paid their annual insurance deductibles in full, thereby reducing their out-of-pocket costs. In the first quarter of each year in Europe, we have experienced, and may in the future experience, reduced demand for our Inspire therapy as Neue Untersuchungs-und-Behandlungsmethoden ("NUB") coverage status is being determined and as hospitals are establishing their budgets pertaining to allocation of funds to purchase our Inspire therapy.

Liquidity and Capital Resources

Our sources of capital have historically been from public and private sales of our securities, sales of our Inspire system and borrowings under credit facilities.

As of June 30, 2020, we had cash, cash equivalents and investments of $242.6 million and an accumulated deficit of $219.5 million, compared to cash, cash equivalents and investments of $155.7 million and an accumulated deficit of $180.2 million as of December 31, 2019.

The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial markets. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, access to sources of liquidity and financial condition. However, we believe that our existing cash resources will be sufficient to meet our capital requirements and fund our operations for at least the next 12 months. We may also seek liquidity through additional securities offerings or through borrowings under a new credit facility. We cannot assure investors that we will be able to obtain such financing on commercially reasonable terms if at all.

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Cash Flows

The following table presents a summary of our cash flow for the periods indicated:


	Six Months Ended
	June 30,
	2020		2019
	(in thousands)
Net cash provided by (used in):
Operating activities	$	(40,026)	$	(23,826)
Investing activities	101,160		(23,066)
Financing activities	127,232		875
Effect of exchange rate on cash	11		(3)
Net increase (decrease) in cash and cash equivalents	$	188,377	$	(46,020)

Operating Activities

The net cash used in operating activities was $40.0 million for the six months ended June 30, 2020 and consisted of a net loss of $39.3 million, a decrease in net operating assets of $7.3 million and an increase in non-cash charges of $6.6 million. The non-cash charges consisted of stock-based compensation, non-cash lease expense, depreciation and amortization, stock issued for services rendered, and accretion of the debt discount, offset by the non-cash income related to the accretion of the investment discount, and other, net. Operating assets includes inventories, which increased due to continued manufacturing of systems inventory while sales decreased due to the COVID-19 pandemic, and prepaid expenses and other current assets, which increased primarily due to the prepayment of insurance premiums. Operating assets also include accounts receivable which decreased due to decreased sales due to the COVID-19 pandemic beginning in March 2020. Operating liabilities includes accrued expenses, which decreased primarily due to the payment of accrued compensation as annual bonuses were paid during the first quarter of 2020. Operating liabilities also includes accounts payable, which increased generally due to the costs to support the growth of our operations, including compensation and personnel-related costs.

The net cash used in operating activities was $23.8 million for the six months ended June 30, 2019 and consisted of a net loss of $15.9 million, an increase in net operating assets of $10.9 million and non-cash charges of $2.9 million. Net operating assets consisted of prepaid expenses and other current assets, accounts receivable, accrued expenses, inventories, and accounts payable to support the growth of our operations. Non-cash charges consisted of stock-based compensation, accretion of debt discount, non-cash lease expense, depreciation and amortization, and stock issued for services rendered, offset by the non-cash income related to the accretion of the investment discount and other, net. These changes were generally driven by our increased revenues year-over-year, which resulted in increases to accounts receivable, inventories, prepaid expenses and other expenditures, including compensation and personnel-related costs.

Investing Activities

Net cash provided by investing activities for the six months ended June 30, 2020 was $101.2 million and consisted primarily of proceeds from sales or maturities of investments of $116.7 million, partially offset by purchases of investments of $14.9 million and purchases of property and equipment of $0.6 million.

Net cash used in investing activities for the six months ended June 30, 2019 was $23.1 million and consisted primarily of purchases of investments of $101.0 million, partially offset by proceeds from sales or maturities of investments of $79.2 million. Purchases of property and equipment, net were $1.2 million.

Financing Activities

Net cash provided by financing activities was $127.2 million for the six months ended June 30, 2020 and consisted primarily of $124.7 million in proceeds from our follow-on offering in April 2020. Proceeds from the exercise of stock

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options of $1.5 million and proceeds from the issuance of common stock from our ESPP of $1.1 million made up the remainder of the cash provided by financing activities.

Net cash provided by financing activities was $0.9 million for the six months ended June 30, 2019 and consisted of $0.8 million in proceeds from the exercise of stock options and $0.6 million in proceeds from issuance of common stock from the employee stock purchase plan, partially offset by a $0.5 million final payment fee due upon the amendment of our credit facility.

Indebtedness

In August 2015, we entered into a loan and security agreement with Oxford Finance LLC ("Oxford Finance"), as lender and collateral agent. The loan and security agreement initially provided for a term A loan facility in the amount of $15.5 million, which was fully funded on the closing date, and a term B loan facility in an amount of at least $3.5 million but no more than $10.0 million, to be available in the future subject to our achievement of certain revenue milestones. We refer to our term A loan facility and our term loan B facility together as our credit facility. In February 2017, we amended the loan and security agreement to, among other things, increase borrowings under the term A loan facility by $1.0 million, increase the minimum amount of the term B loan facility to $5.0 million and reduce the maximum amount of the term B loan facility to $9.0 million. As of June 30, 2020, we had $24.5 million of outstanding borrowings under our credit facility. No borrowings remain available under this credit facility.

In March 2019, we amended the loan and security agreement. Following such amendment, outstanding borrowings under the credit facility bear interest at an annual rate equal to the sum of (i) the greater of (A) the 30 day U.S. LIBOR rate reported in The Wall Street Journal on the last business day of the month that immediately precedes the month in which the interest will accrue or (B) 2.50%, plus (ii) 5.10%; provided, however, under no circumstances will the basic rate be less than 7.60%. We are required to make monthly payments of interest only through April 1, 2022. Following the interest-only period, we will be required to make monthly payments of interest and principal in 24 consecutive monthly installments. Outstanding borrowings under the credit facility mature on March 1, 2024. On the maturity date, in addition to our regular monthly payments of principal and accrued interest, we will be required to make a payment of 3.50% of the total amount borrowed under the credit facility, which we refer to as the Final Payment, unless we have already made such payment in connection with an acceleration or prepayment of borrowings under the credit facility.

Borrowings under the facility are pre-payable at our option in whole, but not in part, together with all accrued and unpaid interest thereon and, if not previously made, the Final Payment, subject to a prepayment fee of 2.0% if such borrowings are prepaid prior to March 27, 2021 and 1.0% if such borrowings are on or after March 27, 2021 and prior to maturity. We are also required to prepay the amounts outstanding under the credit facility upon the occurrence of certain customary events of default, as well as the occurrence of certain material adverse events. The credit facility also includes certain customary affirmative and negative covenants, but does not include any financial covenants. The credit facility is secured by substantially all of our personal property other than our intellectual property. We were in compliance with all covenants under the credit facility as of June 30, 2020.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements, as defined by applicable regulations of the SEC, that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.

Contractual Obligations and Commitments

There have been no material changes to our contractual obligations and commitments from those described in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

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Critical Accounting Policies and Estimates

Our critical accounting policies and estimates are described in "Management's Discussion and Analysis of Financial Condition and Results of Operations—Critical Accounting Policies and Estimates" in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. We have reviewed and determined that those critical accounting policies and estimates remain our critical accounting policies and estimates as of and for the three and six months ended June 30, 2020. Other than the adoption of ASU 2016-13 described in Note 2, no changes were made to our critical accounting policies during the periods presented.

Recent Accounting Pronouncements

We have reviewed all recently issued standards and have determined that, other than as disclosed in Note 2 and Note 4 to our unaudited financial statements included elsewhere in this Quarterly Report on Form 10-Q, such standards will not have a significant impact on our financial statements or do not otherwise apply to our operations.

Item 3. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

The risk associated with fluctuating interest rates is primarily limited to our cash equivalents which are carried at quoted market prices and our investments. If overall interest rates had decreased by 100 basis points during the six months ended June 30, 2020, our interest income would have decreased by approximately $1.0 million. We do not currently use or plan to use financial derivatives in our investment portfolio.

The interest rate for our outstanding debt is variable. If overall interest rates had increased by 100 basis points during the six months ended June 30, 2020 our interest expense would have increased by approximately $0.3 million.

Credit Risk, Foreign Currency Risk, and Inflation Risk

For market risks related to changes in credit, foreign currency and inflation, reference is made to Item 7A “Quantitative and Qualitative Disclosures About Market Risk” contained in Part II of our Annual Report on Form 10-K for the year ended December 31, 2019. Our exposure to these risks has not materially changed from those disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Item 4. Controls and Procedures.

Evaluation of disclosure controls and procedures

The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, refers to controls and other procedures that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure. Our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives, and our management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our management, with the participation of our chief executive officer and our chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q. Based on that evaluation, our chief executive officer and our chief financial officer concluded that our disclosure controls and

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procedures were effective, at the reasonable assurance level, as of the end of the period covered by this Quarterly Report on Form 10-Q.

Changes in internal control over financial reporting.

There were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarter ended June 30, 2020 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, including with respect to any changes implemented in response to the COVID-19 pandemic.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings.

We are not party to any material legal proceedings.

Item 1A. Risk Factors.

For a discussion of our potential risks and uncertainties, see the information in Part I, "Part I, Item IA. Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019. Other than the risk factor set forth below, there have been no material changes to the risk factors disclosed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019.

Our business, financial condition, results of operations and growth could be significantly harmed by the effects of the COVID-19 pandemic.

We are subject to risks related to public health crises such as the global pandemic associated with COVID-19. In 2020, a novel strain of coronavirus, SARS-CoV-2, and the resulting disease COVID-19, has spread around the world and to all 50 states within the United States. The COVID-19 pandemic has negatively impacted our business, results of operations and financial condition by significantly decreasing and delaying the number of Inspire therapy procedures performed and patients screened for eligibility for Inspire therapy, and we expect the COVID-19 pandemic to continue to negatively impact our business, results of operations and financial condition. The number of Inspire therapy procedures performed, similar to other elective surgical procedures, has significantly decreased as health care organizations in the United States and globally have prioritized the treatment of patients with COVID-19. For example, in March 2020 in the United States, governmental authorities began recommending, and in certain cases requiring, that elective, specialty and other procedures and appointments, be suspended or canceled to avoid non-essential patient exposure to medical environments and potential infection with COVID-19 and to focus limited resources and personnel capacity toward the treatment of COVID-19 patients. Specifically, substantially all of our Inspire therapy procedures were postponed beginning in the second week of March and numerous other cases, which received prior authorization approval, were not able to be scheduled and therefore were also postponed. During April 2020, the widespread shutdown in elective surgical procedures continued, with surgical volumes increasing in May and even further in June, yet still remaining below pre-COVID-19 levels. The resurgence of COVID-19 in various U.S. regions has, and will likely continue to, adversely impact our procedure volumes. These measures and challenges will likely continue for the duration of the pandemic, which is uncertain, and will continue to significantly reduce our revenue and negatively impact our business, results of operations and financial condition while the pandemic continues. Further, once the pandemic subsides, we anticipate there will be substantial backlog of patients seeking appointments with physicians and surgeries to be performed at hospitals and ambulatory surgery centers relating to a variety of medical conditions, and as a result, patients seeking Inspire therapy procedures performed will have to navigate limited provider capacity. We believe this limited provider, hospital and ambulatory surgery center capacity could have a significant adverse effect on our business, results of operations and financial condition following the end of the pandemic.

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Numerous state and local jurisdictions have imposed, and others in the future may impose, ‘‘shelter-in-place’’ orders, quarantines, executive orders and similar government orders and restrictions for their residents to control the spread of COVID-19. Starting in late March 2020, the governor of Minnesota, where our headquarters are located, has issued ‘‘stay at home’’ orders and other orders limiting non-essential activities, travel and business operations. Such orders or restrictions have resulted in our headquarters closing, work stoppages, slowdowns and delays, travel restrictions and cancellation of events, among other effects, thereby significantly and negatively impacting our operations. Other disruptions or potential disruptions include restrictions on our personnel and personnel of partners to travel and access customers for training and case support; inability of our suppliers to manufacture and test our Inspire therapy and its components and to deliver these on a timely basis, or at all; inventory shortages or obsolescence; delays in approvals by regulatory bodies; delays in ongoing preclinical trials; delays in operations at insurance agencies, which may impact timelines for the issuance of insurance coverage policies and local coverage determinations delays; diversion of or limitations on employee resources that would otherwise be focused on the operations of our business, including because of sickness of employees or their families or the desire of employees to avoid contact with large groups of people; delays in growing or reductions in our sales team, including through delays in hiring, lay-offs, furloughs or other losses of sales representatives; and additional government requirements or other incremental mitigation efforts that may further impact our or our suppliers’ capacity to manufacture our Inspire system. The extent to which the COVID-19 pandemic impacts our business will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity and spread of COVID-19, future waves of infection, and the actions to contain COVID-19 or treat its impact, among others.

While the potential economic impact brought by and the duration of COVID-19 may be difficult to assess or predict, the widespread pandemic has resulted in, and may continue to result in, significant disruption of global financial markets, reducing our ability to access capital, which could in the future negatively affect our liquidity. In addition, a recession or market correction resulting from the spread of COVID-19 could materially affect our business. The COVID-19 pandemic has also resulted in a significant increase in unemployment in the United States which may continue even after the pandemic. The occurrence of any such events may lead to reduced disposable income and access to health insurance which could adversely affect the number of Inspire systems sold after the pandemic has ended.

To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in ‘‘Risk Factors’’ in our Annual Report on Form 10-K for the year ended December 31, 2019, such as those relating to our significant operating losses, dependence on the Inspire therapy and achieving and maintaining adequate levels of coverage or reimbursement for our products.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

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Item 6. Exhibits.

Exhibit
Number

Description

Form

File No.

Exhibit

Filing
Date

Filed/
Furnished
Herewith

3.1

Seventh Amended and Restated Certificate of Incorporation of Inspire Medical Systems, Inc.

8-K

001-38468

3.1

5/7/2018

3.2

Amended and Restated Bylaws of Inspire Medical Systems, Inc.

8-K

001-38468

3.2

5/7/2018

10.1

Employment Agreement between the Company and Philip Ebeling, effective June 1, 2020.

8-K

001-38468

10.1

6/8/2020

31.1

Certification of Principal Executive Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

31.2

Certification of Principal Financial Officer Pursuant to Rules 13a-14(a) and 15d-14(a) under the Securities Exchange Act of 1934, as Adopted Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

32.1

Certification of Principal Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

32.2

Certification of Principal Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

101.INS

Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document

101.SCH

Inline XBRL Taxonomy Extension Schema Document

101.CAL

Inline XBRL Taxonomy Extension Calculation Linkbase Document

101.DEF

Inline XBRL Taxonomy Extension Definition Linkbase Document

101.LAB

Inline XBRL Taxonomy Extension Label Linkbase Document

101.PRE

Inline XBRL Taxonomy Extension Presentation Linkbase Document

104

Cover Page Interactive Data File (formatted as Inline XBRL and contained in Exhibit 101)

_______________________________________________________________________________

* Filed herewith.

** Furnished herewith.

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Inspire Medical Systems, Inc.

Date:

August 4, 2020

By:

/s/ TIMOTHY P. HERBERT

Timothy P. Herbert

President, Chief Executive Officer and Director

(principal executive officer)

Date:

August 4, 2020

By:

/s/ RICHARD J. BUCHHOLZ

Richard J. Buchholz

Chief Financial Officer

(principal financial officer and principal accounting officer)