Inogen Inc 10-Q

Item 2: Management’s Discussion and Analysis of Financial Condition and Results of Operations Forward - Looking Statements The following discussion and analysis should be read together with our consolidated financial statements and the condensed notes to those statements included elsewhere in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, or the Securities Act, and Section 21E of the Securities Exchange Act of 1934, as amended, or the Exchange Act, that are based on our management’s beliefs and assumptions and on information currently available to our management. The forward-looking statements are contained principally in the section entitled “Risk Factors” and this Management’s Discussion and Analysis of Financial Condition and Results of Operations. Forward-looking statements include, but are not limited to, statements concerning the following: • information concerning our possible or assumed future cash flows, revenue, sources of revenue and results of operations, operating and other expenses; • our assessment and expectations regarding the impact of the COVID-19 public health emergency (PHE) on our business; • our assessment and expectations regarding reimbursement rates, future rounds of competitive bidding, Centers for Medicare and Medicaid Services (CMS) changes associated with the COVID-19 PHE impacting respiratory care, and future changes in rental revenue; • our expectations regarding regulatory approvals and government and third-party payor coverage and reimbursement; • our ability to develop new products, improve our existing products and increase the value of our products, including the integration of non-invasive ventilation (NIV) technology into our existing business; • our expectations of the impact of the COVID-19 PHE on sales, productivity, hiring, media expenditures, physician-based sales team and physician referrals, and worldwide demand for oxygen and NIV therapies; • our expectations regarding the timing of new products and product improvement launches, as well as product features and specifications; • market share expectations, unit sales, business strategies, financing plans, expansion of our business, competitive position, industry environment, and potential growth opportunities; • our expectations regarding the market size, market growth and the growth potential for our business; • our ability to grow our business and enter new markets; • our expectations regarding the average selling prices and manufacturing costs of our products, including our expectations to continue to reduce average unit costs for our systems; • our expectations regarding our sales and marketing strategy channels; • our expectations with respect to our European and U.S. facilities and our expectations with respect to our contract manufacturer in Europe; • our expectations regarding tariffs being imposed by the U.S. on certain imported materials and products; • our ability to successfully acquire and integrate companies and assets, including our recent acquisition of New Aera, Inc. (New Aera); • our expectations regarding the impact and implementation of trade regulations on our supply chain; • our expectations regarding excess tax benefits or deficiencies from stock-based compensation; • our expectations of future accounting pronouncements or changes in our accounting policies; • our assessments and estimates of our effective tax rate; • our internal control environment; • the effects of seasonal trends on our results of operations and estimated hiring plans; • our expectation that our existing capital resources and the cash to be generated from expected product sales and rentals will be sufficient to meet our projected operating and investing requirements for at least the next twelve months; and • the effects of competition. 29 Forward-looking statements include statements that are not historical facts and can be identified by terms such as “anticipates,” “believes,” “could,” “seeks,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” or similar expressions and the negatives of those terms. Forward-looking statements involve known and unknown risks, uncertainties, and other 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. We discuss these risks in greater detail in Part II, Item 1A, “Risk Factors,” elsewhere in this Quarterly Report on Form 10-Q and in our Annual Report on Form 10-K filed with the Securities and Exchange Commission, or SEC. Given these uncertainties, you should not place undue reliance on these forward-looking statements. Moreover, we operate in a very competitive and rapidly changing environment. New risks emerge from time to time. It is not possible for us to predict all risks, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements we may make. In light of these risks, uncertainties and assumptions, the future events and trends discussed in this Quarterly Report on Form 10-Q may not occur and actual results could differ materially and adversely from those anticipated or implied in the forward-looking statements. The forward-looking statements made in this Quarterly Report on Form 10-Q relate only to events as of the date on which the statements are made. Except as required by law, we assume no obligation to update these forward-looking statements, or to update the reasons actual results could differ materially from those anticipated in these forward-looking statements, even if new information becomes available in the future. This Quarterly Report on Form 10-Q also contains estimates, projections and other information concerning our industry, our business, and the markets for certain diseases, including data regarding the estimated size of those markets, and the incidence and prevalence of certain medical conditions. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events and circumstances reflected in this information. Unless otherwise expressly stated, we obtained this industry, business, market and other data from reports, research surveys, studies and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data and similar sources. “Inogen,” “Inogen One,” “Inogen One G2,” “Inogen One G3,” “G4,” “G5,” “Live Life in Moments, not Minutes,” “Never Run Out of Oxygen,” “Oxygen Therapy on Your Terms,” “Oxygen.Anytime.Anywhere,” “Reclaim Your Independence,” “Intelligent Delivery Technology,” “Inogen At Home,” the Inogen design, “TIDAL ASSIST,” “TAV,” and “SIDEKICK” are registered trademarks with the United States Patent and Trademark Office of Inogen, Inc. We own pending applications for “Inogen,” “MOMENTUM TRANSFER” and “SONIC BLADE” with the United States Patent and Trademark Office. We own trademark registrations for the mark “Inogen” in Argentina, Australia, Canada, China, Columbia, Ecuador, South Korea, Mexico, Europe (European Union Registration), Iceland, India, Israel, Japan, Kuwait, New Zealand, Norway, Peru, Turkey, Singapore, and Switzerland. We own pending applications for the mark “Inogen” in Australia, Brazil, Chile, China, Europe (European Union application), India, Malaysia, Paraguay, South Africa and Uruguay. We own a trademark registration for the mark “イノジェン” in Japan. We own trademark registrations for the marks “印诺真” and “艾诺根” in China. We own trademark registrations for the mark “Inogen One” in Australia, Canada, China, South Korea, Mexico, and Europe (European Union Registration). We own a trademark registration for the mark “Satellite Conserver” in Canada. We own a trademark registration for the mark “Inogen At Home” in Europe (European Union Registration). We own trademark registrations for the mark “G4” in Europe (European Union Registration) and the United Kingdom. We own trademark registrations for the mark “G5” in Europe (European Union Registration) and the United Kingdom. We own trademark applications for the Inogen design in Bolivia and China. We own a trademark application for the mark “إنوجن” in Saudi Arabia. Other service marks, trademarks, and trade names referred to in this Quarterly Report on Form 10-Q are the property of their respective owners. In this Quarterly Report on Form 10-Q, “we,” “us” and “our” refer to Inogen, Inc. and its subsidiaries. The following discussion of our financial condition and results of operations should be read together with our consolidated financial statements and the accompanying condensed notes to those statements included elsewhere in this document. Also, forward-looking statements represent our management’s beliefs and assumptions only as of the date of this Quarterly Report on Form 10-Q. 30 Critical accounting policies and significant estimates Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements which have been prepared in accordance with generally accepted accounting principles in the United States of America, or U.S. GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue and expenses at the date of the financial statements. Generally, we base our estimates on historical experience and on various other assumptions in accordance with U.S. GAAP that we believe to be reasonable under the circumstances. Actual results may differ from these estimates and such differences could be material to the financial position and results of operations. There have been no material changes in our critical accounting policies and estimates in the preparation of our consolidated financial statements during the three and six months ended June 30 , 2020 compared to those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019, as filed with the SEC on February 25, 2020. COVID-19 PHE The novel coronavirus outbreak of COVID-19 has had and likely will continue to have significant adverse effects on businesses and healthcare institutions around the world. While it is not possible at this time to estimate the overall impact that the COVID-19 PHE could have on our business, the continued rapid spread of COVID-19, both across the United States and throughout much of the world, and the measures taken by the governments of countries and local authorities affected has adversely impacted and will likely continue to adversely impact our business operations, demand for our products, the manufacture or shipment of our products, and our financial condition and operating results. Our priorities during the COVID-19 PHE include protecting the health and safety of our employees and supporting our patients and customers. Given the COVID-19 impact to the respiratory system, oxygen therapy is prescribed by healthcare professionals for treatment and recovery for certain patients with COVID-19. We also believe stationary oxygen concentrators, and, secondarily, portable oxygen concentrators (POCs) could provide relief to global hospital systems by allowing appropriate patients to be treated in the home, such as patients early in the disease progression or those in recovery post hospital discharge, thus making room for more severe patients who need treatment in the hospital. However, the COVID-19 PHE adversely impacted our consolidated operating results in the three months ended June 30, 2020. We experienced lower direct-to-consumer sales starting toward the end of the first quarter of 2020 and continuing throughout the second quarter of 2020. We believe the social distancing, self-quarantine and related mandates and behaviors emanating from the COVID-19 PHE, including shelter-in-place orders, reduced travel, and lower consumer confidence reduced direct-to-consumer sales. While there was an initial surge in demand for oxygen concentrators by our home medical equipment (HME) providers early in the COVID-19 PHE, business-to-business demand declined in the second quarter of 2020 due to physician offices limiting patient interactions for chronic obstructive pulmonary disease (COPD) patient referrals, lower retail sales, HME providers minimizing patient interactions in response to the COVID-19 PHE, which includes replacing existing oxygen patient setups with POCs, and HME providers turning their purchasing focus to stationary oxygen concentrators to treat COVID-19 patients. Also, sales in Europe declined associated with the temporary closure of certain respiratory assessment centers and continued tender delays in certain markets due to the COVID-19 pandemic. The COVID-19 PHE has also and could continue to lead to volatility in consumer access to our products due to government actions impacting our ability to produce and ship products or impacting consumers’ movements and access to our products. The COVID-19 PHE has caused and may continue to cause reduced demand for our products across all channels due to the global economic environment and reduced regular physician interactions and testing which could lead to a lower rate of diagnosis for long-term oxygen therapy. Additionally, while we initially planned for sales and marketing expansion in 2020, we believe this would have been negatively impacted due to the COVID-19 PHE, which may reduce the close rates on patients who contact us resulting in less efficient marketing spend, reduce the number of oxygen therapy patients who respond to our marketing campaigns, reduce the number of sales representatives hired, or impact the results or timing of a pricing trial. Given these uncertainties, we have implemented cost savings by decreasing personnel hires, suspending our 401(k) match effective July 1, 2020, and reducing advertising spend, while also increasing rental setups to improve lead utilization. The health and safety of our people and their families continues to be our primary focus. Our ability to continue to operate without any significant negative operational impacts will in part depend on our ability to protect our employees and our supply chain. As the COVID-19 PHE has developed, we have taken numerous steps to help ensure the health and safety of our employees and their families. We follow recommended actions of government and health authorities to protect our employees, with particular measures in place for those working in our manufacturing facilities. Employees whose tasks can be done offsite have been instructed to work from home and most of our total personnel continue to work from home. We have also worked closely with local and national officials to keep our manufacturing facilities open due to the essential nature of our products. For the six months ended June 30, 2020, we were able to broadly maintain our operations. We intend to continue to work with government authorities and implement our employee safety measures to help ensure that we are able to continue manufacturing and shipping our products during the COVID-19 PHE. However, the COVID-19 PHE could result in an unforeseen disruption to our supply chain that could impact our operations. 31 For additional information on risk factors that could impact our results, please refer to “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q . Overview We are a medical technology company that primarily develops, manufactures and markets innovative POCs used to deliver supplemental long-term oxygen therapy to patients suffering from chronic respiratory conditions. Long-term oxygen therapy is defined as the provision of oxygen therapy for use at home in patients who have chronic low blood oxygen levels (hypoxemia). Traditionally, these patients have relied on stationary oxygen concentrator systems for use in the home and oxygen tanks or cylinders for mobile use, which we call the delivery model. The tanks and cylinders must be delivered regularly and have a finite amount of oxygen, which requires patients to plan activities outside of their homes around delivery schedules and a finite oxygen supply. Additionally, patients must attach long, cumbersome tubing to their stationary concentrators simply to enable mobility within their homes. Our proprietary Inogen One ® systems concentrate the air around the patient to offer a single source of supplemental oxygen anytime, anywhere with a portable device weighing as little as approximately 2.8 pounds with a single battery. Our Inogen One systems range from 2.6 to 6.5 hours of battery life with a single battery and can be plugged into an outlet when at home, in a car, or in a public place with outlets available. We believe our Inogen One systems reduce the patient’s reliance on stationary concentrators and scheduled deliveries of tanks with a finite supply of oxygen, thereby improving patient quality of life and fostering mobility. We believe that we were the first oxygen therapy manufacturer to employ a direct-to-consumer marketing strategy, meaning we advertise directly to patients, process their physician paperwork, and provide clinical support as needed, which we believe has contributed to our market leadership position in the POC market. While other manufacturers have also begun direct-to-consumer marketing campaigns to drive patient sales, we believe we are the only POC manufacturer that employs a direct-to-consumer rental strategy in the United States, meaning we bill Medicare or insurance on the consumer’s behalf. We derive the majority of our revenue from the sale and rental of our Inogen One systems and related accessories to patients, insurance carriers, home healthcare providers, resellers, charitable organizations, and distributors, including our private label partner. We sell multiple configurations of our Inogen One and Inogen At Home systems with various batteries, accessories, warranties, power cords and language settings. We also rent our products to Medicare beneficiaries and patients with other insurance coverage to support their long-term oxygen needs as prescribed by a physician as part of a care plan. Our goal is to design, build and market oxygen solutions that redefine how long-term oxygen therapy is delivered. To accomplish this goal and to grow our revenue, we intend to: • Expand our domestic direct-to-consumer sales and physician-based sales teams and increase productivity. During the year ended December 31, 2019, the number of inside sales representatives decreased to 329 from 446 as of December 31, 2018; however, overall sales representative productivity improved during the period. In the second half of 2019, we restarted our sales capacity expansion efforts with a more measured approach, selectively hiring new sales representatives across all three of our facilities. Going forward, except as otherwise limited by the impact of the COVID-19 PHE, our long-term plan is to continue to hire to expand sales capacity while focusing on increased productivity, improved sales personnel and lead distribution systems, improved training, and more emphasis on the availability of the Inogen One G5 ® , which has higher patient preference. We also plan to expand our physician referral team to drive increased physician referrals for rental patients and direct-to-consumer sales. This specialized sales team consisted of 20 employees as of December 31, 2019. However, our sales expansion and productivity improvements planned in 2020 have been negatively impacted due to the COVID-19 PHE. As a result of the COVID-19 PHE, we slowed down sales representative additions in the second quarter of 2020 and plan to primarily focus on replacement of attrition for the remainder of 2020. We believe this has reduced and may continue to reduce the number of oxygen therapy patients who purchase our products through our direct-to-consumer sales channel. We have seen and believe we could continue to see a decline in sales in our direct-to-consumer channel until patient mobility and consumer confidence increases. As this is a dynamic situation, we plan to continue to monitor the COVID-19 PHE in the United States and may adjust our sales plans accordingly. • Expand our domestic direct-to-consumer marketing, drive better lead utilization, and optimize pricing. We expended $40.3 million in media and advertising costs in 2019 compared to $30.8 million in 2018, to drive greater patient awareness of our products and increase patient inquiries about their ability to switch from their current oxygen products to our technology. Media and advertising costs declined to $7.2 million in the second quarter of 2020 compared to $11.6 million in the second quarter of 2019, primarily associated with reductions due to the COVID-19 PHE and increased focus on new rental setups. We initially planned to continue to increase marketing spend to drive consumer and physician awareness of our products in 2020. We also initially planned to perform a pricing trial in 2020 to optimize pricing in our direct-to-consumer sales channel as well as look for opportunities to improve the close rate of leads through product offerings, pricing, and partnerships with HME providers. However, due to the COVID-19 PHE, we revised these plans as discussed in our Quarterly Report on Form 10-Q for the period ended March 31, 2020, and we are continuing to reduce marketing spend during the COVID-19 PHE due to the lower return on those investments and to conserve cash. As this is a dynamic situation, we plan to continue to monitor the progression of the COVID-19 PHE in the United States and may adjust our marketing plan accordingly. 32 • Expand our domestic HME provider and reseller sales in the face of reimbursement uncertainty. We are also focused on building our domestic business-to-business partnerships, including relationships with distributors, key accounts, resellers, our private label partner, traditional HME providers , and charitable organizations . We offer patient-preferred, low service cost products and financing programs to help providers convert their businesses to a non-delivery POC business model. While HME providers have been adopting our products in prior quarters, growth has been challenged due to difficulties in their ongoing efforts to restructure from the delivery business model to the non-delivery portable model, lack of access to available credit, provider capital expenditure constraints, and pending competitive bidding Round 2021 and the lack of visibility to who will win contracts and any change in reimbursement rates. However, supplemental oxygen is a treatment prescribed by healthcare professionals for some patients with COVID-19. While there was an initial surge in demand for oxygen concentrators by our HME providers early in the COVID-19 PHE, business-to-business demand declined in the second quarter of 2020 due to physician offices limiting patient interactions for COPD patient referrals, lower retail sales, HME providers minimizing patient interactions in response to the COVID-19 PHE which includes replacing existing oxygen patient setups with POCs, and HME providers turning their purchasing focus to stationary oxygen concentrators to treat COVID-19 patients. • Expand our rental revenues through a dedicated rental intake team. During the year ended December 31, 2019, we added a rental intake team to focus exclusively on new rental additions to drive overall sales productivity and simplify training. We ended 2019 with 25 patient intake representatives and administrative personnel and have scaled and plan to continue to scale the rental intake team in 2020, which we believe will lead to increased patients on service and growth in rental revenue in future periods. Due to the COVID-19 PHE, we have also seen Medicare and commercial payors reduce the administrative burden for oxygen therapy, which we believe will increase rental setups during the COVID-19 PHE, and we have also seen increased reimbursement rates in some areas for Medicare beneficiaries, which should also increase rental revenue during the COVID-19 PHE. • Increase international business-to-business adoption. Although our main growth opportunity remains POC adoption in the United States given what we still believe is a relatively low penetration rate, we believe there is a large international market opportunity. In order to take advantage of these international markets, we have built out an infrastructure over the past few years, which includes sales in 46 international countries and a contract manufacturing partner, Foxconn, located in the Czech Republic to support European sales volumes. As in the United States, while there was an initial surge in demand for oxygen concentrators by our international HME customers early in the COVID-19 pandemic, international demand declined in the second quarter of 2020 due to the temporary closure of certain European respiratory assessment centers due to the COVID-19 pandemic and continued tender delays in certain European markets. In addition, as in the United States, providers turned their focus to supplying stationary oxygen concentrators with higher flow characteristics in response to the COVID-19 pandemic. To grow our international sales markets, we are also in the process of developing regulatory and sales pathways to capture opportunities in new and emerging markets. We expect to begin sales in the Chinese market as early as the end of 2021 although this could be delayed due to regulatory clearance delays, other impacts of the COVID-19 pandemic or government actions, by the United States or China that impose barriers or restrictions that would impact our ability to access the Chinese market. Over time, as the U.S. and European markets mature, our growth will depend on our ability to drive POC adoption in emerging markets, where limited oxygen therapy treatment exists today. However, growth may also be limited by currency fluctuations, capital expenditure constraints, ongoing restructuring challenges, and tender uncertainty. • Invest in our oxygen product offerings to develop innovative products . We incurred $3.3 million and $1.5 million for the three months ended June 30, 2020 and June 30, 2019, respectively, and $6.9 million and $3.1 million for the six months ended June 30, 2020 and June 30, 2019, respectively, in research and development expenses, and we intend to continue to make such investments in the foreseeable future. We launched our fifth-generation POC, the Inogen One G5, in our direct-to-consumer channel during the second quarter of 2019, in our domestic business-to-business channel during the third quarter of 2019, and in certain markets in our international business-to-business channel in the fourth quarter of 2019. Some international markets require additional regulatory or reimbursement clearances to release the product, and we are in the process of obtaining additional clearances to access additional markets. The Inogen One G5 weighs 4.7 pounds and produces 1,260 ml per minute of oxygen output, with very quiet operation at 38 dBA and our longest battery life at 6.5 hours for a single battery and up to 13 hours for a double battery. We estimate that the Inogen One G5 is suitable for over 90% of ambulatory long-term oxygen therapy patients based on our analysis of the patients who have contacted us and their clinical needs. We expect the Inogen One G5 to obsolete the Inogen One G3 ® over the intermediate term. We expect manufacturing cost for our Inogen One G5 to be at parity with our Inogen One G3 in the third quarter of 2020, and we still expect the Inogen One G5 to be our lowest cost to manufacture over time. The Inogen One G5 represented more than 66% of total domestic POC units sold in the six months ended June 30, 2020, showing the strong demand for this product from both patients and providers. 33 Inogen Connect, our connectivity platform on our Inogen One G4 ® and Inogen One G5 products in the United States and Canada is compatible with Apple and Android platforms and includes patient features such as purity status, battery life, product support functions, notification alerts, and remote software updates. We believe home oxygen providers will also find features such as remote troubleshooting, equipment health checks, and location tracking to help drive operational efficiencies when transitioning away from the oxygen tank delivery model. • Expand our product offerings. In August 2019, we acquired New Aera. New Aera’s patented and FDA-cleared Tidal Assist ® Ventilator (TAV ® ) system is designed to deliver increased air flow and pressure from an approximately 4-ounce pocket-size unit, features a state-of-the-art nasal pillow interface, and is compatible with certain oxygen concentrators, oxygen cylinders, wall gas, and certain medical air sources. TAV therapy with oxygen has been clinically demonstrated during periods of exercise to reduce breathlessness, increase exercise endurance, and improve oxygen saturation for patients suffering from certain chronic lung disease compared to oxygen therapy alone. We began a limited launch of the TAV product in December 2019 in our domestic direct-to-consumer channel and in our domestic business-to-business channel. We plan to only sell this product across our domestic direct-to-consumer channel and in our domestic business-to-business channel in the remainder of 2020, although we expect limited contributions to revenue in 2020. The COVID-19 PHE also had an impact on sales of this product in the second quarter of 2020, primarily due to lower retail demand. We plan to incorporate the TAV technology directly into our Inogen One POCs and make the TAV product compatible with our Inogen At Home stationary concentrators to continue to advance patient preference and maintain our technology leadership position in the long-term oxygen therapy market. In addition, we plan to use this technology as a platform to expand our total addressable market into the high-growth NIV market, where we believe there is a significant worldwide untreated market opportunity. We believe this market could undergo disruption similar to oxygen given the immobile nature of legacy NIV product offerings. The monthly Medicare reimbursement rate is significantly higher for NIV products than oxygen therapy at a minimum of $934 a month. Also, effective January 1, 2019, a new Medicare Healthcare Common Procedure Coding System (HCPCS) code has been added to allow billing for a multi-function ventilator that includes both ventilation and oxygen. It is uncertain if the TAV product acquired from New Aera will be reimbursable in its current configuration under HCPCS code E0466. We requested confirmation on the assigned HCPCS codes for the TAV system from the Pricing, Data Analysis, and Coding (PDAC) Contractor in August 2019 following the closing of the New Aera transaction. In August 2019, we received positive confirmation that this product was assigned HCPCS code E0466. However, in September 2019, we received a revised communication that the product was assigned HCPCS code E1390 and E1352, which was then revoked at our request in December 2019. In September 2019, we appealed to the CMS, and in January 2020 our appeal was denied. We are currently pursuing additional appeal opportunities. If we do not receive revised coding, it could limit this product’s adoption by HME providers and also our direct rentals until revisions are made to the product to meet the coding requirements. In addition, the Medicare Coverage Advisory Committee (MEDCAC) recently had a meeting on July 22, 2020 to discuss home use of non-invasive positive pressure ventilation in patients with chronic respiratory failure consequent to COPD. CMS is seeking MEDCAC’s recommendations regarding the characteristics that define those patient selection and usage criteria. This request could signal forthcoming changes in Medicare coverage of these items, and possibly changes in HCPCS codes, which could impact our NIV business and growth initiatives. For a discussion of certain significant risks relating to the TAV reimbursement, see the risk factor entitled “ The competitive bidding process under Medicare could negatively affect our business and financial condition .” We have been developing and refining the manufacturing of our Inogen One systems since 2004. While nearly all of our manufacturing and assembly processes were originally outsourced, assembly of the compressors, sieve beds, concentrators and certain manifolds were brought in-house in order to improve quality control and reduce cost. In support of our European sales, we use a contract manufacturer located in the Czech Republic to manufacture high volume products and perform product repairs to improve delivery to our European accounts. We expect to maintain our assembly operations for our products at our facilities in Richardson, Texas and Goleta, California. In 2020, we are focused on reducing the cost of our Inogen One G5 product, expanding manufacturing of the TAV product and our oxygen concentrator products, and increasing the robustness of our supply chain to reduce potential component constraints as we grow our business. We also use lean manufacturing practices to maximize manufacturing efficiency. We rely on third-party manufacturers to supply several components of our products. We typically enter into master service agreements for these components that specify quantity and quality requirements and delivery terms. In certain cases, these agreements can be terminated by either party upon relatively short notice. We have elected to source certain key components from single sources of supply, including our batteries, motors, valves, TAV-compatible stationary concentrators, columns, and some molded plastic components. We believe that maintaining a single source of supply allows us to control production costs and inventory levels and to manage component quality. In order to mitigate against the risks related to a single source of supply, for certain components we qualify alternative suppliers and develop contingency plans for responding to disruptions. However, any reduction or halt in supply from one of these single-source 34 suppliers could limit our ability to manufacture our products or devices until a replacement supplier is found and qualified. For additional discussion of potential risks related to our manufacturing and raw materials, please see the risk factor entitled “ We obtain some of the components, subassemblies and completed products included in our products from a single source or a limited group of manufacturers or suppliers, and the partial or complete loss of one or more of these manufacturers or suppliers could cause significant production delays, an inability to meet customer demand, substantial loss in revenue, and an adverse effect on our financial condition and results of operations. ” Historically, we have generated a majority of our revenue from sales and rentals to customers in the United States. In the three months ended June 30, 2020 and June 30, 2019, approximately 19.3% and 22.3%, respectively, and 21.2% and 22.2% for the six months ended June 30, 2020 and June 30, 2019, respectively, of our total revenue was from sales to customers outside the United States, primarily in Europe. Approximately 77.2% and 71.8% of the non-U.S. revenue for the three months ended June 30, 2020 and June 30, 2019, respectively, and 72.2% and 71.6% for the six months ended June 30, 2020 and June 30, 2019, respectively, was invoiced in Euros with the remainder invoiced in United States dollars. We sell our products in 46 countries outside the United States through our wholly-owned subsidiary, distributors or directly to large “house” accounts, which include gas companies, HME oxygen providers, and resellers. In those instances, we sell to and bill the distributor or “house” accounts directly, leaving responsibility for the patient billing, support and clinical setup to the local provider. Our total revenue was $71.7 million and $101.1 million for the three months ended June 30, 2020 and June 30, 2019, respectively, and $160.2 million and $191.3 million for the six months ended June 30, 2020 and June 30, 2019, respectively. The decrease in total revenue in the three months ended June 30, 2020 compared to the three months ended June 30, 2019 was primarily due to a decline in direct-to-consumer sales and domestic and international business-to-business sales, primarily associated with the COVID-19 PHE. Similarly, the decrease in total revenue in the six months ended June 30, 2020 compared to the six months ended June 30, 2019, was primarily due to a decline in direct-to-consumer sales and domestic and international business-to-business sales, primarily associated with the COVID-19 PHE. We generated net income of $2.6 million and $10.2 million for the three months ended June 30, 2020 and June 30, 2019, respectively, and $1.0 million and $15.5 million for the six months ended June 30, 2020 and June 30, 2019, respectively. We generated Adjusted EBITDA of $10.0 million and $16.8 million in the three months ended June 30, 2020 and June 30, 2019, respectively, and $14.1 million and $27.9 million for the six months ended June 30, 2020 and June 30, 2019, respectively, (see “Non-GAAP financial measures” for reconciliations between U.S. GAAP and non-GAAP results). As of June 30, 2020, our retained earnings were $82.4 million. Sales revenue Our future financial performance will be driven in part by the growth in sales of our Inogen One systems, and, to a lesser extent, sales of batteries, other accessories, our Inogen At Home stationary oxygen concentrators and our TAV products. We plan to grow our system sales in the coming years through multiple strategies including: hiring additional sales representatives, productivity improvements, investing in consumer awareness through increased marketing efforts, expanding our sales infrastructure and efforts outside of the United States, expanding our business-to-business sales through key partnerships, and enhancing our product offerings through additional product launches, although, as mentioned above, these plans have been and may continue to be impacted by the COVID-19 PHE. While we believe most HME providers are still in the process of converting their business model to a non-delivery model and purchase POCs, growth has been challenged and we expect it could continue to be challenged due to the COVID-19 PHE, their ongoing restructuring efforts, lack of access to available credit, provider capital expenditure constraints, and pending competitive bidding Round 2021 with the lack of visibility to who will win contracts and any change in reimbursement rates. As our product offerings grow, we solicit feedback from our customers and focus our research and development efforts on continuing to improve patient preference and reduce the total cost of the product in order to further drive sales of our products. Our direct-to-consumer sales process involves numerous interactions with the individual patient, their physician and the physician’s staff, and includes an in-depth analysis and review of our product, the patient’s diagnosis and prescribed oxygen or NIV therapy, including procuring an oxygen prescription, although, as discussed above, this process has been disrupted due to the COVID-19 PHE and we expect that such disruption will continue for the duration of the COVID-19 PHE. The patient may consider whether to finance the product through an Inogen-approved third-party or purchase the equipment. Product is not deployed until both the prescription and payment are received. Once a full system is deployed, the patient has 30 calendar days to return the product, subject to the payment of a minimal processing and handling fee. Approximately 6-10% of consumers who purchase a system return the system during this 30-day return period. 35 Our business-to-business efforts are focused on selling to distributors, HME oxygen and NIV providers, our private label partner , resellers, and charitable organizations who are based inside and outside of the United States. This process involves interactions with various key customer stakeholders including sales, purchasing, product testing, and clinical personnel. Businesses that have patient demand that can be met with our products place purchase orders to secure product deployment. This may be influenced based on outside factors, including the result of tender offerings, changes in insurance plan coverage, business restructuring activities toward a non-delivery model, capital constraints, and overall changes in the net oxygen and NIV therapy patient populations , and is presently being impacted by the COVID-19 PHE . Products are shipped freight on board (FOB) Inogen dock domestically, and based on financial history and profile, businesses may either prepay or receive extended payment terms. Products are shipped both FOB Inogen dock and Delivery Duty Paid (DDP) for certain international shipments depending on the shipper used. DDP shipments are Inogen’s property until title has transferred which is upon duty being paid and delivered to the customer. As a result of these factors, product purchases can be subject to changes in demand by customers. We sold approximately 42,500 systems in the three months ended June 30, 2020 and 56,500 systems for the same period in 2019. We sold approximately 95,900 systems in the six months ended June 30, 2020 compared to 106,900 systems for the same period in 2019. Management focuses on system sales as an indicator of current business success. Rental revenue Our direct-to-consumer rental process involves numerous interactions with the individual patient, their physician and the physician’s staff. The process includes an in-depth analysis and review of our product, the patient’s diagnosis and prescribed oxygen or NIV therapy, and their medical history to confirm the appropriateness of our product for the patient’s oxygen therapy or NIV therapy and compliance with Medicare and private payor billing requirements, which often necessitates additional physician evaluation and/or testing as well as a Certificate of Medical Necessity for oxygen. Once the product is deployed, the patient receives instruction on product use and may receive a clinical titration from our licensed staff to confirm the product meets the patient’s medical oxygen needs prior to billing. As a result, the period of time from initial contact with a patient to billing can vary significantly and be up to one month or longer. However, due to the COVID-19 PHE, CMS has reduced the paperwork requirements for Medicare oxygen therapy patients, as discussed in more detail in the Reimbursement section below, effective in early March 2020. Rental revenue increased in the three months ended June 30, 2020 as compared to the three months ended June 30, 2019, primarily due to a greater number of patients on service and higher Medicare reimbursement rates. Medicare reimbursement rates for oxygen therapy increased 1.5% to 3.5%, effective January 1, 2020. In addition, as part of the CARES Act (discussed in more detail in the Reimbursement section below), the 2% Medicare sequestration reduction was temporarily eliminated, and Medicare reimbursement rates for non-rural, non-competitive bid areas through the duration of the COVID-19 PHE were increased to a 75/25 blended rate retroactive to March 6, 2020. The 50/50 blended rate for HME providers in rural and non-contiguous, non-competitive bid areas was also extended for the duration of the COVID-19 PHE, which could increase the rates in 2021 if the COVID-19 PHE continues. We plan to add new rental patients on service in future periods through multiple strategies, including expanding our rental intake team and physician-based sales teams, expanding our direct-to-consumer marketing efforts, investing in patient and physician awareness, and securing additional insurance contracts. A portion of rentals include a capped rental period during which no additional reimbursement is allowed unless additional criteria are met. In this scenario, the ratio of billable patients to total patients on service is critical to maintaining rental revenue growth as patients on service increases. Medicare has noted a certain percentage of beneficiaries, approximately 25%, based on their review of Medicare claims, reach the 36 th month of eligible reimbursement and enter the capped rental period. The percentage of capped patients may fluctuate over time as new patients come on service, patients come off of service before and during the capped rental period, and existing patients enter the capped rental period. We had approximately 26,400 and 25,900 oxygen rental patients as of June 30, 2020 and June 30, 2019, respectively. Management focuses on patients on service as a leading indicator of likely future rental revenue; however, actual rental revenue recognized is subject to a variety of other factors, including reimbursement levels by payor, patient location, the number of capped patients, write-offs for uncollectable balances, and rental revenue adjustments. Reimbursement Medicare and private insurance rentals represented 8.5% and 5.1% of our total revenue in the three months ended June 30, 2020 and June 30, 2019, respectively, and 7.1% and 5.5% in the six months ended June 30, 2020 and June 30, 2019, respectively. In cases where we rent our long-term oxygen therapy solutions directly to patients, we bill third-party payors, such as Medicare or private insurance, for monthly rentals on behalf of our patients. We process and coordinate all physician paperwork necessary for reimbursement of our solutions. A common medical criterion for long-term oxygen therapy reimbursement is insufficient blood oxygen saturation level. Our team in sales and rental intake are trained on how to verify benefits, review medical records and process physician paperwork. Additionally, an independent internal review is performed, and our products are not deployed until after physician paperwork is processed and reimbursement eligibility is verified and communicated to the patient. 36 We rely significantly on reimbursement from Medicare and private payors, including Medicare Advantage plans, Medicaid and patients for our rental revenue. For the three and six months ended June 3 0 , 20 20 , approximately 80.0 % and 79.2 %, respectively, of our rental revenue was derived from Medicare’s traditional fee-for-service reimbursement programs. The U.S. list price for our stationary oxygen rentals (HCPCS E1390) is $260 per month and the U.S. list price for our oxygen generating portable equipment (OGPE) rentals (HCPCS E1392) is $70 per month. The average Medicare reimbursement rates in competitive bidding areas (CBAs) in 2018 were $77.03 a month for E1390 and $36.06 a month for E1392. These are the two primary codes that we bill to Medicare and other payors for our oxygen product rentals. There have been significant U.S. reimbursement and policy changes associated with the COVID-19 PHE that impact oxygen therapy. The CARES Act allows the U.S. Department of Health and Human Services (HHS) to waive certain Medicare telehealth payment requirements during the COVID-19 PHE declared by the HHS on January 31, 2020 to allow beneficiaries in all areas to receive telehealth services, including at their home, starting March 6, 2020. H.R. 6074 also granted authority to waive certain requirements. Under this authority, CMS clarified that HHS would not conduct audits to determine whether there was a prior physician-patient relationship for telehealth claims submitted during the COVID-19 PHE. The CARES Act included the extension of the 50/50 blended rate for HME in rural and non-contiguous, non-competitively bid areas and established a new 75/25 blended rate for all other non-competitively bid areas through the duration of the COVID-19 PHE. The 75/25 blended rate is retroactive to March 6, 2020. While the duration of the current emergency is impossible to predict, the Zika virus PHE lasted approximately 360 days, and the H1N1 flu PHE lasted approximately 450 days. The CARES Act also included a temporary elimination of the 2% percent Medicare sequestration reduction that went into effect in 2013. This relief is effective May 1, 2020 through December 31, 2020, and extends the end date of the sequester by one year, through 2030, in order to offset the 2020 suspension. On April 6, 2020, an Interim Final Rule (IFR) was published in the Federal Register for policy and regulatory revisions in response to the COVID-19 PHE. There was a comment period until June 1, 2020. This IFR included that for the duration of the COVID-19 PHE, the face-to-face requirements and clinical indications of coverage for home oxygen, among other respiratory products, will be waived. In addition, the administration has issued a number of regulatory waivers to increase the flexibility in DMEPOS suppliers’ ability to service patients quickly and without the normal requirements. For example, the patient’s signature for proof of delivery has been waived when signatures cannot be collected during the COVID-19 PHE. In addition, CMS increased Medicare contractors’ ability to waive replacement product requirements, paused the national prior authorization program for certain DMEPOS, automatically extended expiring accreditations, granted contractors the flexibility to grant appeals extensions, and medical review suspension. Both the IFR and temporary regulatory changes show significant flexibility from CMS to improve access for oxygen and other DMEPOS items during this COVID-19 PHE. These changes were retroactive to early March 2020. However, in July 2020, CMS released a COVID-19 Product Burden Relief FAQs that included updates to this IFR, including that the pausing of the national prior authorization program for certain DMEPOS and medical review suspension will likely end, effective August 3, 2020. Effective January 1, 2019, Medicare beneficiaries may receive durable medical equipment from any Medicare-enrolled supplier until new contracts are in effect under competitive bidding Round 2021, which is expected to begin on January 1, 2021. Reimbursement rates between January 1, 2019 and December 31, 2020 are set at the current pricing level throughout the United States for all Medicare patients, subject to Consumer Price Index (CPI) and budget neutrality adjustments. Pricing in CBAs is subject to annual CPI adjustments beginning in 2019 until Round 2021 begins. However, CMS also changed the calculation on budget neutrality to apply the offset to all oxygen and oxygen equipment classes beginning January 1, 2019 instead of previously only applying these adjustments to stationary oxygen equipment and oxygen contents. Based on these CPI and budget neutrality adjustments, effective January 1, 2019 the average Medicare reimbursement rates in former CBAs decreased to $72.92 a month for E1390 and $35.72 a month for E1392. Medicare also established new payment classes for liquid oxygen equipment and high flow portable liquid oxygen contents effective January 1, 2019. Effective January 1, 2020, the average Medicare reimbursement rates were increased by 1.5% to $73.98 a month for E1390 and $36.25 a month for E1392 in these regions that were previously subject to competitive bidding. In addition, the average Medicare reimbursement rates in non-rural, non-former CBAs increased by 3.5% to $74.84 a month for E1390 and $36.87 a month for E1392. In Round 2021 of durable medical equipment, prosthetics, orthotics and supplies (DMEPOS) competitive bidding program, there have been some revisions to the bidding methodology including bid surety bond requirements, lead item pricing, and setting reimbursement rates at the maximum winning bid rate instead of the median winning bid rate. In the prior round of competitive bidding, our products were categorized in the product category of respiratory equipment and related supplies and accessories, which included oxygen equipment, continuous positive airway pressure (CPAP) devices and respiratory assist devices (RADs) and related supplies and accessories. In Round 2021 of the competitive bidding program, oxygen and oxygen equipment is its own product category and the lead item has been established as E1390. However, due to the lead item pricing methodology based on the 2015 standard Medicare fee schedule, E1392 reimbursement rates could be reduced significantly (we estimate approximately 42%) even if E1390 reimbursement rates do not change. This would lead to combined E1390 plus E1392 reimbursement rates to decrease by approximately 15%. The bidding window closed on September 18, 2019, and we bid in 129 of the 130 total CBAs. It is unclear how pricing will be impacted due to these new bids. We expect contracts and pricing to be announced in 2020. 37 In addition to regional pricing, CMS imposed different pricing on “frontier states” and rural areas. CMS defines frontier states as states where more than 50% of the counties in the state have a population density of 6 people or less per square mile and rural states are defined as states where more than 50% of the population lives in rural areas per census data. Current frontier states include MT, ND, SD and WY; rural states include ME, MS, VT and WV; and non-contiguous United States areas include AK, HI, Guam and Puerto Rico. Effective June 1, 2018 through December 31, 2020, for frontier and rural states, frontier and rural zip codes in non-frontier/rural states and non-contiguous United States areas, the single payment amount will be 50/50 blended reimbursement rates based on an average of the pre-competitive bidding reimbursement rates and the current average reimbursement rates to account for higher servicing costs in these areas. In 2019, this rate was $134.71 a month for E1390 and $44.32 a month for E1392, and this rate increased by 1.5% effective January 1, 2020 to $136.71 a month for E1390 and $44.93 a month for E1392. We estimate that approximately 15% of our patients are eligible to receive the higher reimbursement rates based on the geographic locations of our current patient population. Cumulatively in previous rounds of competitive bidding, we were offered contracts for a substantial majority of the CBAs and product categories for which we submitted bids. As of January 1, 2017, we believe we had access to over 90% of the Medicare oxygen therapy market based on our analysis of the 103 CBAs that we won out of the 130 total CBAs. These 130 CBAs represented approximately 36% of the Medicare market with the remaining approximately 64% of the market not subject to competitive bidding per Medicare’s data on 2018 traditional Medicare fee-for-service beneficiaries in CBAs as compared to the total Medicare fee-for-service beneficiaries. As of January 1, 2019, we can choose to accept Medicare oxygen patients throughout the United States. As of July 2018, we are operating in all 50 states in the U.S. We cannot guarantee that we will be offered contracts in subsequent rounds of competitive bidding. In all five rounds of competitive bidding in which we have participated, we have gained access to certain CBAs and been excluded from other CBAs. Medicare revenue, including patient co-insurance and deductible obligations, represented 6.8% and 5.6% of our total revenue in the three and six months ended June 30, 2020, respectively. Medicare reimbursement for oxygen rental equipment is limited to a maximum of 36 months within a 60-month service period, and the equipment remains the property of the home oxygen supplier. The supplier that billed Medicare for the 36th month of service continues to be responsible for the patient’s oxygen therapy needs for months 37 through 60, and there is generally no additional reimbursement for OGPE for these later months. Medicare does not separately reimburse suppliers for oxygen tubing, cannulas and supplies that may be required for the patient. The supplier is required to keep the equipment provided in working order and in some cases, Medicare will reimburse for repair costs. At the end of the five-year useful life of the equipment, the patient may request replacement equipment and, if he or she can be re-qualified for the Medicare benefit, a new maximum 36-month payment cycle out of the next 60 months of service would begin. The supplier may not arbitrarily issue new equipment. We have analyzed the potential impact to revenue associated with patients in the capped rental period and have deferred $0 associated with the capped rental period for the three and six months ended June 30, 2020 and June 30, 2019, respectively. Our capped patients as a percentage of total patients on service was approximately 17.2% as of June 30, 2020 and 20.2% as of June 30, 2019. The percentage of capped patients may fluctuate over time as new patients come on service, patients come off of service before and during the capped rental period, and existing patients enter the capped rental period. Our obligations to service Medicare patients over the rental period include supplying working equipment that meets each patient’s oxygen needs pursuant to his/her doctor’s prescription and certificate of medical necessity form and supplying all disposables required for the patient to operate the equipment, including cannulas, filters, replacement batteries, carts and carry bags, as needed. If the equipment malfunctions, we must repair or replace the equipment. We determine what equipment the patient receives, as long as that equipment meets the physician’s prescription, and we can deploy used assets in working order as long as the prescription requirements are met. We must also procure a recertification of the certificate of medical necessity from the patient’s doctor to confirm the patient’s need for continued oxygen therapy one year after the patient first receives oxygen therapy and one year after each new 36-month reimbursement period begins. The patient can choose to receive oxygen supplies and services from another supplier at any time, but the supplier may only transition the patient to another supplier in certain circumstances. Average Medicare reimbursement rates for NIV HCPCS code E0466 were a monthly, non-capped rental with rates of $1,042.26 a month in 2019, and increased 0.9% effective January 1, 2020 to $1,051.64 a month, excluding Puerto Rico where the monthly Medicare reimbursement rate for E0466 was $1,827.24 per month in 2019 and increased to $1,843.69 a month effective January 1, 2020. 38 It is uncertain if the current TAV product acquired from New Aera, will be reimbursable in its current configuration under HCPCS code E0466. We requested confirmation on the assigned HCPCS codes for the TAV system from the PDAC Contractor in August 2019 following the closing of the New Aera transaction. In August 2019, we received positive confirmation that this product was assigned HCPCS code E0466. However, in September 2019, we received a revised communication that the product was assigned HCPCS code E1390 and E1352, which was then revoked at our request in December 2019. In September 2019, we appealed to CMS, and in January 2020 our appeal was denied. We are currently pursuing additional appeal opportunities. If we do not receive revised coding, it could limit this product’s adoption by HME providers and also our direct rentals. In addition, the M EDCAC recently had a meeting on July 22, 2020 to discuss home use of non-invasive positive pressure ventilation in patients with chronic respiratory failure consequent to COPD. CMS is seeking MEDCAC’s recommendations regarding the characteristics that define patient selection and usage criteria for these items . This request could signal forthcoming changes in Medicare coverage of these items, and possibly changes in HCPCS codes, which could impact our NIV business and growth initiatives. For a discussion of certain significant risks relating to the TAV reimbursement and the upcoming round of competitive bidding, see the risk factor entitled “ The competitive bidding process under Medicare could negatively affect our business and financial condition.” As of June 30, 2020, we had 90 contracts with Medicaid, Medicare Advantage, government and private payors. These contracts qualify us as an in-network provider for these payors. As a result, patients can rent or purchase our systems at the same patient obligation as other in-network oxygen suppliers. Based on our patient population, we believe at least 44% of all oxygen therapy patients are covered by Medicare Advantage, government, and other private payors. Private payors typically provide reimbursement at a rate similar to Medicare allowables for in-network plans. We anticipate that private payor reimbursement levels will generally be reset in accordance with Medicare payment amounts. We believe that we are well positioned to respond to the changing reimbursement environment because our product offerings are innovative, patient-focused and cost-effective. We have historically been able to reduce our costs through scalable manufacturing, better sourcing, continuous innovation, and reliability improvements, as well as innovations that reduce our product service costs by minimizing exchanges. As a result of design changes, supplier negotiations, bringing manufacturing and assembly largely in-house and our commitment to driving efficient manufacturing processes, we have reduced our overall POC system cost by approximately 59% from 2009 to 2019. We intend to continue to seek ways to reduce our cost of revenue through manufacturing and design improvements. For additional discussion of the impact of the recent Medicare reimbursement proposals, see “Risk Factors” herein. Basis of presentation The following describes the line items set forth in our consolidated statements of comprehensive income (loss). Revenue We classify our revenue in two main categories: sales revenue and rental revenue. There will be fluctuations in mix between business-to-business sales, direct-to-consumer sales and rental revenue from period-to-period. Product selling prices and gross margins may fluctuate as we introduce new products, reduce our product costs, have changes in purchase volumes, and as currency variations occur. For example, the gross margin for our Inogen One G4 system is higher than our Inogen One G3 system due to lower manufacturing costs and similar average selling prices. Thus, to the extent our sales of our Inogen One G4 systems are higher than sales of our Inogen One G3 systems, our overall gross margins should improve and, conversely, to the extent our sales of our Inogen One G3 systems are higher than sales of our Inogen One G4 systems, our overall gross margins should decline. Quarter-over-quarter results may vary due to seasonality in both the international and domestic markets. We believe our sales may be impacted by seasonal factors. For example, we typically experience higher total sales in the second and third quarters as a result of consumers traveling and vacationing during warmer weather in the spring and summer months, but this may vary year-over-year. Particularly, due to the mandates and behaviors emanating from the COVID-19 PHE, including shelter-in-place orders, reduced travel, and lower consumer confidence, we did not see the typical seasonal increases in direct-to-consumer sales in the second quarter of 2020 that we have seen in prior years. As more HME providers adopt POCs in their businesses, we expect our historical seasonality in the domestic business-to-business channel could change as well, which was previously influenced mainly by consumer buying patterns. Direct-to-consumer sales seasonality may also be impacted by the number of our sales representatives and the amount of marketing spend in each quarter. Sales revenue Our sales revenue is primarily derived from the sale of our Inogen One systems, Inogen At Home systems, TAV systems, and related accessories to individual consumers, our private label partner, HME providers, distributors, resellers, and charitable organizations worldwide. Sales revenue is classified into two areas: business-to-business sales and direct-to-consumer sales. Generally, our direct-to-consumer sales have higher gross margins than our business-to-business sales. 39 Rental revenue Our rental revenue is primarily derived from the rental of our Inogen One and Inogen At Home systems to patients through reimbursement from Medicare, private payors and Medicaid, which typically also includes a patient responsibility component for patient co-insurance and deductibles. Rental revenue increased in the three and six months ended June 30, 2020, primarily due to higher patients on service and higher Medicare reimbursement rates. We expect our rental revenue to increase in future periods as we scale the rental intake team, increase new rental setups, and benefit from the higher Medicare reimbursement rates for oxygen therapy. We also expect that our rental revenue will be impacted by the number of our sales and rental intake representatives, reimbursement rate changes including the impact of COVID-19 PHE changes, Round 2021 competitive bidding, the level of and response from potential customers to direct-to-consumer marketing spend, product launches, and other uncontrollable factors such as changes in the market and competition. Cost of revenue Cost of sales revenue Cost of sales revenue consists primarily of costs incurred in the production process, including component materials, assembly labor and overhead, warranty, provisions for slow-moving and obsolete inventory, rework and delivery costs for items sold. Labor and overhead expenses consist primarily of personnel-related expenses, including wages, bonuses, benefits, and stock-based compensation for manufacturing, logistics, repair, manufacturing engineering, and quality assurance employees and temporary labor. Cost of sales revenue also includes manufacturing freight in, depreciation expense, facilities costs and materials. We provide a 3-year, 5-year or lifetime warranty on Inogen One systems sold and a 3-year and lifetime warranty on Inogen At Home systems sold. The TAV system has a 1-year and a 3-year warranty. We establish a reserve for the cost of future warranty repairs based on historical warranty repair costs incurred as well as historical failure rates. Provisions for warranty obligations, which are included in cost of sales revenue, are provided for at the time of revenue recognition. We continue to make progress towards reducing the average unit costs of our products as a result of our ongoing efforts to develop lower-cost systems, negotiate with our suppliers, improve our manufacturing processes, and increase production volume and yields. At the same time, recent United States policies related to global trade and tariffs may also increase our average unit cost. The current economic environment has introduced greater uncertainty with respect to potential trade regulations, including changes to United States policies related to global trade and tariffs. We continue to monitor the Section 301 tariffs being imposed by the United States on certain imported Chinese materials and products in addition to potential retaliatory responses from other nations. In 2019 and the six months ended June 30, 2020, the impact of the Chinese tariffs on our financial results was minimal as we have received some exemptions, negotiated cost sharing and price reductions with suppliers, and re-allocated purchases. Assuming the Chinese tariffs stay at the current levels, we currently expect the overall financial impact to our business to be minimal to the average unit cost for 2020. We expect the TAV system to have a higher sales gross margin than our existing oxygen therapy products. For these reasons, we expect sales gross margin percentage to fluctuate over time based on the sales channel mix, product mix, and changes in average selling prices and cost per unit. Cost of rental revenue Cost of rental revenue consists primarily of depreciation expense; service costs for rental patients, including rework costs, material, labor, freight, and consumable disposables; and logistics costs. We expect rental gross margin percentage to increase over time, primarily associated with higher rental revenue per patient and lower costs. We expect the average cost of rental revenue per patient to decline in future periods as a result of our ongoing efforts to reduce average unit cost of our systems as well as reductions in depreciation, service costs, and logistics costs. 40 Operating expense Research and development Our research and development expense consists primarily of personnel-related expenses, including wages, bonuses, benefits and stock-based compensation for research and development and engineering employees, facility costs, laboratory supplies, product development materials, consulting fees and related costs, and testing costs for new product launches as well as enhancements to existing products. We have made substantial investments in research and development since our inception. Our research and development efforts have focused primarily on the tasks required to enhance our technologies and to support development and commercialization of new and existing products. Beginning in the third quarter of 2019, research and development expense also includes intangible amortization costs associated with the New Aera acquisition, which is expected to substantially increase our research and development expense in 2020 through 2028 by approximately $7.8 million per year and $4.9 million in 2029. We plan to continue to invest in research and development activities to stay at the forefront of patient preference in oxygen therapy and NIV devices. We expect research and development expense to increase in absolute dollars in future periods as we continue to invest in our engineering and technology teams to support our new and enhanced product research and development efforts and manufacturing improvements. We expect increased research and development costs associated with the New Aera acquisition to incorporate the TAV technology into our oxygen concentrator and new non-invasive ventilator product portfolios as well as intangible amortization costs. Sales and marketing Our sales and marketing expense primarily supports our direct-to-consumer sales and rental strategy and consists mainly of personnel-related expenses, including wages, bonuses, commissions, benefits, and stock-based compensation for sales, marketing, customer service, rental intake, and clinical service employees. It also includes expenses for media and advertising, printing, informational kits, dues and fees, credit card fees, recruiting, training, sales promotional activities, travel and entertainment expenses as well as allocated facilities costs. Sales and marketing expense decreased in the three months ended June 30, 2020 as compared to June 30, 2019, primarily due to reduced advertising spend. Our average sales representative headcount in the second quarter of 2020 was relatively flat compared to the second quarter of 2019, and our plan was to hire additional sales representatives at a more controlled pace across all of our facilities to expand sales capacity for the remainder of 2020. However, due to the COVID-19 PHE, we have reduced and expect to continue to reduce marketing spend and reduce sales representative headcount additions and primarily focus on replacement of attrition of existing sales representatives for the remainder of 2020. However, we still expect a further increase in sales and marketing expense in future periods as we continue to invest in our business, including expanding our sales and sales support team, increasing media spend to drive consumer awareness, and rising patient support costs as our patient and customer base increases. We also expect increased sales and marketing costs in 2020 associated with the expanded launch of the TAV product following the limited launch in December 2019. General and administrative Our general and administrative expense consists primarily of personnel-related expenses, including wages, bonuses, benefits, and stock-based compensation for employees in our compliance, finance, medical billing, order intake, human resources, and information technology (IT) departments as well as facilities costs, sales bad debt expense, and board of directors’ expenses, including stock-based compensation. In addition, general and administrative expense includes professional services, such as legal, patent registration and defense costs, insurance, consulting and accounting services, including audit and tax services, and travel and entertainment expenses. We expect general and administrative expense to increase in future periods as the number of administrative personnel grows and we continue to introduce new products, broaden our customer base and grow our business. We expect general and administrative expense to increase in absolute dollars as we continue to invest in corporate infrastructure to support our growth including personnel-related expenses, professional services fees and compliance costs associated with operating as a public company. Those costs include increases in our accounting, human resources, and IT personnel, as well as increases in additional consulting, legal and accounting fees, facilities costs, insurance costs, and board of directors’ compensation. 41 Other income (expense), net Our other income (expense), net consists primarily of interest income earned on cash equivalents and marketable securities as well as foreign currency gains and (losses). Income taxes We account for income taxes in accordance with ASC 740— Income Taxes . Under ASC 740, income taxes are recognized for the amount of taxes payable or refundable for the current period and deferred tax liabilities and assets are recognized for the future tax consequences of transactions that have been recognized in our consolidated financial statements or tax returns. A valuation allowance is provided when it is more likely than not that some portion, or all, of the deferred tax asset will not be realized. We account for uncertainties in income tax in accordance with ASC 740-10— Accounting for Uncertainty in Income Taxes . ASC 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. This accounting standard also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The accounting for stock-based compensation will increase or decrease our effective tax rate based upon the difference between our stock-based compensation expense and the deductions taken on our U.S. tax return, which depends upon the stock price at the time of employee option exercise or award vesting. We recognize excess tax benefits or deficiencies on a discrete basis, and we anticipate our effective tax rate will vary from quarter-to-quarter depending on our stock price in each period. Results of operations Comparison of three months ended June 30, 2020 and June 30, 2019 Revenue Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Sales revenue $ 65,612 $ 95,863 $ (30,251 ) -31.6 % 91.5 % 94.9 % Rental revenue 6,079 5,200 879 16.9 % 8.5 % 5.1 % Total revenue $ 71,691 $ 101,063 $ (29,372 ) -29.1 % 100.0 % 100.0 % Sales revenue decreased $30.3 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or a decrease of 31.6% from the comparable period. The decrease was primarily attributable to reduced direct-to-consumer sales and reduced domestic and international business-to-business sales, primarily associated with the impacts of the COVID-19 PHE. We sold approximately 42,500 oxygen systems during the three months ended June 30, 2020 compared to approximately 56,500 oxygen systems sold during the three months ended June 30, 2019, or a decrease of 24.8%. The decrease in the number of systems sold resulted mainly from a decrease in sales across all channels, primarily due to the COVID-19 PHE. Rental revenue increased $0.9 million for the three months ended June 30, 2020 compared to the three months ended June 30, 2019, or an increase of 16.9% from the comparable period. The increase in rental revenue was primarily related to a 1.9% increase in rental patients on service, higher Medicare reimbursement rates, and increased billable patients from the comparative period. Three months ended (amounts in thousands) June 30, Change 2020 vs. 2019 % of Revenue Revenue by region and category 2020 2019 $ % 2020 2019 Business-to-business domestic sales $ 21,564 $ 29,653 $ (8,089 ) -27.3 % 30.1 % 29.4 % Business-to-business international sales 13,874 22,564 (8,690 ) -38.5 % 19.3 % 22.3 % Direct-to-consumer domestic sales 30,174 43,646 (13,472 ) -30.9 % 42.1 % 43.2 % Direct-to-consumer domestic rentals 6,079 5,200 879 16.9 % 8.5 % 5.1 % Total revenue $ 71,691 $ 101,063 $ (29,372 ) -29.1 % 100.0 % 100.0 % Domestic business-to-business sales decreased 27.3% for the three months ended June 30, 2020 compared to the three months ended June 30, 2019. The decrease was primarily the result of decreased demand from our HME partners for oxygen concentrators in response to the COVID-19 PHE due to physician offices limiting patient interactions that traditionally have led to new oxygen patient referrals, lower retail sales, HME providers minimizing patient interactions in response to the COVID-19 PHE which includes replacing existing oxygen patient setups with POCs, and HME providers turning their purchasing focus to stationary oxygen concentrators to treat COVID-19 patients. 42 International b usiness-to-business sales decre ased 38.5 % for the three months ended June 3 0 , 20 20 compared to the three months ended June 3 0 , 201 9 , mostly due to decreased demand from our HME partners for oxygen concentrators due to the temporary closure of certain European respiratory assessment centers due to the COVID-19 pandemic and continued tender delays in certain European markets. In addition, like in the United States, HME provider s turned their purchasing focus to stationary oxygen concentrators to treat COVID-19 patients . In the three months ended June 3 0 , 20 20 , sales in Europe as a percentage of total international sales revenue decreased to 87.2 % versus 88.2 % in the comparative period in 201 9 , primarily because of the reduced sales in Europe. Domestic direct-to-consumer sales decreased 30.9% for the three months ended June 30, 2020 compared to the three months ended June 30, 2019, primarily due to the impact of the COVID-19 PHE with government mandated shelter-in-place initiatives, reduced consumer travel, and lower consumer confidence, which decreased demand and associated close rates in the second quarter of 2020 compared to the same period in the prior year. Average sales representative headcount was relatively flat in the comparative periods. Cost of revenue and gross profit Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Cost of sales revenue $ 36,082 $ 47,230 $ (11,148 ) -23.6 % 50.3 % 46.7 % Cost of rental revenue 2,860 3,618 (758 ) -21.0 % 4.0 % 3.6 % Total cost of revenue $ 38,942 $ 50,848 $ (11,906 ) -23.4 % 54.3 % 50.3 % Gross profit - sales revenue $ 29,530 $ 48,633 $ (19,103 ) -39.3 % 41.2 % 48.1 % Gross profit - rental revenue 3,219 1,582 1,637 103.5 % 4.5 % 1.6 % Total gross profit $ 32,749 $ 50,215 $ (17,466 ) -34.8 % 45.7 % 49.7 % Gross margin percentage - sales revenue 45.0 % 50.7 % Gross margin percentage- rental revenue 53.0 % 30.4 % Total gross margin percentage 45.7 % 49.7 % Cost of sales revenue decreased $11.1 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or a decrease of 23.6% from the comparable period. The decrease in cost of sales revenue was primarily attributable to lower sales and related bill of material costs and lower total labor and overhead expense, partially offset by higher cost per unit associated with the Inogen One G5 during the period. Cost of rental revenue decreased $0.8 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or a decrease of 21.0% from the comparable period. The decrease in cost of rental revenue was primarily attributable to reduced rental asset depreciation expense and servicing costs. Cost of rental revenue included $1.2 million of rental asset depreciation for the three months ended June 30, 2020 compared to $1.6 million for the three months ended June 30, 2019. Sales revenue gross margin percentage decreased to 45.0% for the three months ended June 30, 2020 from 50.7% for the three months ended June 30, 2019. The decrease was primarily related to increased mix toward domestic business-to-business sales, which have a lower gross margin than our international business-to-business and direct-to-consumer sales, lower mix of accessory sales, and increased overhead costs per unit due to lower sales volumes. In addition, average selling prices were down in the second quarter of 2020 versus the same period in the prior year across all sales channels. Domestic business-to-business sales revenue accounted for 32.9% of total sales revenue in the three months ended June 30, 2020 versus 30.9% in the three months ended June 30, 2019. Rental revenue gross margin percentage increased to 53.0% for the three months ended June 30, 2020 from 30.4% for the three months ended June 30, 2019, primarily due to higher rental revenue per patient on service and lower depreciation and servicing costs per patient on service. Research and development expense Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Research and development expense $ 3,290 $ 1,468 $ 1,822 124.1 % 4.6 % 1.5 % 43 Research and development expense increased $1.8 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or an increase of 124.1% over the comparable period, primarily due to $1.9 million in intangible amortization costs related to the New Aera acquisition. Sales and marketing expense Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Sales and marketing expense $ 22,086 $ 27,758 $ (5,672 ) -20.4 % 30.8 % 27.5 % Sales and marketing expense decreased $5.7 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or a decrease of 20.4% from the comparable period, primarily attributable to decreases of $4.4 million of lower advertising expense, $0.7 million of lower personnel-related expenses and $0.4 million in credit card processing fees. In the three months ended June 30, 2020, we spent $7.2 million in media and advertising costs versus $11.6 million in the comparative period in 2019. General and administrative expense Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 General and administrative expense $ 9,724 $ 8,844 $ 880 10.0 % 13.6 % 8.7 % General and administrative expense increased $0.9 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or an increase of 10.0% from the comparable period. The increase was primarily related to $1.1 million in consulting fees and $0.9 million for the change in fair value of the New Aera earnout liability, partially offset by the $0.6 million reimbursement from the CARES Act Provider Relief Fund due to the COVID-19 PHE, $0.5 million in lower legal fees, and $0.5 million in lower personnel-related expenses. Other income (expense) Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Interest income $ 176 $ 1,394 $ (1,218 ) -87.4 % 0.2 % 1.4 % Other income 5,700 145 5,555 3831.0 % 8.0 % 0.1 % Total other income, net $ 5,876 $ 1,539 $ 4,337 281.8 % 8.2 % 1.5 % Total other income, net increased $4.3 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or an increase of 281.8% from the comparable period. The increase was primarily attributable to $5.6 million in other income from the CARES Act Provider Relief Fund due to lost revenues from the COVID-19 PHE, partially offset by a decrease of $1.2 million in interest income on marketable securities due to the lower interest rate environment. Income tax expense Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Income tax expense $ 945 $ 3,524 $ (2,579 ) -73.2 % 1.3 % 3.4 % Effective income tax rate 26.8 % 25.8 % Income tax expense decreased $2.6 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, primarily attributable to a 74.2% decrease in income before income tax expense. 44 Our effective tax rate in the three months ended June 3 0 , 20 20 in creased compared to the three months en ded June 3 0 , 201 9 , primarily due to changes in income before income tax expense. In the three months ended June 3 0 , 20 20 , excess tax deficiencies recognized from stock-based compensation in creased our income tax expense by $ 0.3 million and our effective tax rate by 7.3 %, as compared to the tax rate without such deficiencies . For comparison, in the three months ended June 3 0 , 201 9 , excess tax deficiencies recognized from stock-based compensation in c reased our income tax expense by $ 0. 2 million and our effective tax rate by 1.4 %, as compared to the tax rate without such deficiencies . Net income Three months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Net income $ 2,580 $ 10,160 $ (7,580 ) -74.6 % 3.6 % 10.1 % Net income decreased $7.6 million for the three months ended June 30, 2020 from the three months ended June 30, 2019, or a decrease of 74.6% from the comparable period. The decrease in net income was primarily related to lower sales revenue and gross margin as well as a higher effective tax rate, partially offset by lower operating expenses. Comparison of six months ended June 30, 2020 and June 30, 2019 Revenue Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Sales revenue $ 148,752 $ 180,681 $ (31,929 ) -17.7 % 92.9 % 94.5 % Rental revenue 11,428 10,584 844 8.0 % 7.1 % 5.5 % Total revenue $ 160,180 $ 191,265 $ (31,085 ) -16.3 % 100.0 % 100.0 % Sales revenue decreased $31.9 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, or a decrease of 17.7% from the comparable period. The decrease was primarily attributable to reduced direct-to-consumer sales and reduced domestic and international business-to-business sales, primarily due to the impact of the COVID-19 PHE and Inogen One G5 supply constraints in the first quarter of 2020. We sold approximately 95,900 oxygen systems during the six months ended June 30, 2020 compared to approximately 106,900 oxygen systems sold during the six months ended June 30, 2019, or a decrease of 10.3%. The decrease in the number of systems sold resulted mainly from a decrease in sales across all channels primarily due to the COVID-19 PHE and the Inogen One G5 supply constraints in the first quarter of 2020. Rental revenue increased $0.8 million for the six months ended June 30, 2020 compared to the six months ended June 30, 2019, or an increase of 8.0% from the comparable period. The increase in rental revenue was primarily related to higher Medicare reimbursement rates, higher billable patients, and a 1.9% increase in rental patients on service from the comparative period in the prior year. Six months ended (amounts in thousands) June 30, Change 2020 vs. 2019 % of Revenue Revenue by region and category 2020 2019 $ % 2020 2019 Business-to-business domestic sales $ 49,118 $ 55,714 $ (6,596 ) -11.8 % 30.7 % 29.1 % Business-to-business international sales 33,957 42,367 (8,410 ) -19.9 % 21.2 % 22.2 % Direct-to-consumer domestic sales 65,677 82,600 (16,923 ) -20.5 % 41.0 % 43.2 % Direct-to-consumer domestic rentals 11,428 10,584 844 8.0 % 7.1 % 5.5 % Total revenue $ 160,180 $ 191,265 $ (31,085 ) -16.3 % 100.0 % 100.0 % Domestic business-to-business sales decreased 11.8% for the six months ended June 30, 2020 compared to the six months ended June 30, 2019. The decrease was primarily due to decreased demand from our HME partners for oxygen concentrators in response to the COVID-19 PHE due to physician offices limiting patient interactions that traditionally have led to new oxygen patient referrals, lower retail sales, HME providers minimizing patient interactions in response to the COVID-19 PHE which includes replacing existing oxygen patient setups with POCs, and HME providers turning their purchasing focus to stationary oxygen concentrators to treat COVID-19 patients. In addition, lower Inogen One G5 availability early in the period and uncertainty around competitive bidding Round 2021 contributed to lower sales in the period. 45 International b usiness-to-business sales de creased 19.9 % for the six months ended June 3 0 , 2020 compared to the six months ended June 3 0 , 2019, mostly driven by the temporary closure of certain European respiratory assessment centers due to the COVID-19 pandemic and continued tender delays in certain European markets. In addition, like in the United States, HME providers turned their focus to supplying stationary oxygen concentrators with higher flow characteristics in responses to the COVID-19 pandemic . In the six months ended June 3 0 , 2020, sales in Europe as a percentage of total international sales revenue decreased to 85.6 % versus 8 7 . 4 % in the comparative period in 2019, primarily because of r educed sales in Europe. Domestic direct-to-consumer sales decreased 20.5% for the six months ended June 30, 2020 compared to the six months ended June 30, 2019, primarily due to the impact of the COVID-19 PHE with government mandated shelter-in-place initiatives, reduced consumer travel, and lower consumer confidence, which decreased demand and associated close rates in the period compared to the same period in the prior year. In addition, sales declined associated with a decline in average sales representative headcount. Cost of revenue and gross profit Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Cost of sales revenue $ 83,200 $ 89,297 $ (6,097 ) -6.8 % 52.0 % 46.7 % Cost of rental revenue 5,865 7,344 (1,479 ) -20.1 % 3.6 % 3.8 % Total cost of revenue $ 89,065 $ 96,641 $ (7,576 ) -7.8 % 55.6 % 50.5 % Gross profit - sales revenue $ 65,552 $ 91,384 $ (25,832 ) -28.3 % 40.9 % 47.8 % Gross profit - rental revenue 5,563 3,240 2,323 71.7 % 3.5 % 1.7 % Total gross profit $ 71,115 $ 94,624 $ (23,509 ) -24.8 % 44.4 % 49.5 % Gross margin percentage - sales revenue 44.1 % 50.6 % Gross margin percentage- rental revenue 48.7 % 30.6 % Total gross margin percentage 44.4 % 49.5 % Cost of sales revenue decreased $6.1 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, or a decrease of 6.8% from the comparable period. The decrease in cost of sales revenue was primarily attributable to lower sales and related bill of material costs and lower total labor and overhead expense, partially offset by higher cost per unit associated with the Inogen One G5 during the period. Cost of rental revenue decreased $1.5 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, or a decrease of 20.1% from the comparable period. The decrease in cost of rental revenue was primarily attributable to reduced rental asset depreciation expense and servicing costs. Cost of rental revenue included $2.5 million of rental asset depreciation for the six months ended June 30, 2020 compared to $3.3 million for the six months ended June 30, 2019. Sales revenue gross margin percentage decreased to 44.1% for the six months ended June 30, 2020 from 50.6% for the six months ended June 30, 2019. The decrease was primarily related to increased domestic business-to-business sales mix which has a lower gross margin, higher cost of goods sold associated with certain manufacturing inefficiencies in the period that contributed to higher labor and overhead costs per unit, and lower average selling prices. Total domestic business-to-business sales revenue accounted for 33.0% of total sales revenue in the six months ended June 30, 2020 versus 30.8% in the six months ended June 30, 2019. Rental revenue gross margin percentage increased to 48.7% for the six months ended June 30, 2020 from 30.6% for the six months ended June 30, 2019, primarily due to higher rental revenue per patient on service and lower depreciation and servicing costs per patient on service. Research and development expense Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Research and development expense $ 6,895 $ 3,137 $ 3,758 119.8 % 4.3 % 1.6 % 46 Research and development expense increased $ 3.8 million for the six months ended June 3 0 , 20 20 from the six months ended June 3 0 , 201 9 , or an increase of 119.8 % over the comparable period, primarily due to $ 3.9 million in intangible amortization costs related to the New Aera acquisition. Sales and marketing expense Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Sales and marketing expense $ 49,249 $ 55,959 $ (6,710 ) -12.0 % 30.7 % 29.3 % Sales and marketing expense decreased $6.7 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, or a decrease of 12.0% from the comparable period, primarily attributable to decreases of $4.6 million of advertising costs, $2.1 million of personnel-related expenses partially associated with the decline in average sales representative headcount, and $0.5 million in credit card processing fees, partially offset by an increase of $0.6 million in dues, fees and license costs. In the six months ended June 30, 2020, we spent $17.2 million in media and advertising costs versus $21.8 million in the comparative period in 2019. General and administrative expense Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 General and administrative expense $ 19,501 $ 18,525 $ 976 5.3 % 12.2 % 9.7 % General and administrative expense increased $1.0 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, or an increase of 5.3% from the comparable period. The increase was primarily attributable to $1.8 million in professional and consulting fees as well as $0.3 million in facilities costs, partially offset by $0.6 million in lower personnel-related costs, $0.6 million reimbursement from the CARES Act Provider Relief Fund due to the COVID-19 PHE, and $0.3 million in lower legal fees. Other income (expense) Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Interest income $ 728 $ 2,728 $ (2,000 ) -73.3 % 0.4 % 1.4 % Other income 5,640 25 5,615 22460.0 % 3.5 % 0.0 % Total other income, net $ 6,368 $ 2,753 $ 3,615 131.3 % 3.9 % 1.4 % Total other income, net increased $3.6 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, or an increase of 131.3% from the comparable period. The increase was primarily attributable to $5.6 million in other income from the CARES Act Provider Relief Fund due to lost revenues from the COVID-19 PHE, partially offset by a decrease of $2.0 million in interest income on marketable securities due to the lower interest rate environment. Income tax expense Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Income tax expense $ 847 $ 4,294 $ (3,447 ) 80.3 % 0.5 % 2.2 % Effective income tax rate 46.1 % 21.7 % Income tax expense decreased $3.4 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, primarily attributable to a 90.7% decrease in income before income tax expense for the year. Our effective tax rate in the six months ended June 30, 2020 increased compared to the six months ended June 30, 2019, primarily due to the decrease in excess tax benefits recognized from stock-based compensation, partially offset by the changes in 47 income before income tax expense , increase in favorable permanent differences and research and development credits. In the six months ended June 3 0 , 20 20 , excess tax deficiencies recognized from stock-based compensation in creased our income tax expense by $ 0.5 million and our effective tax rate by 26.9 %, as compared to the tax rate without such deficiencies . For comparison, in the six months ended June 3 0 , 201 9 , excess tax benefits recognized from stock-based compensation decreased our income tax expense by $ 0. 4 million and our effective tax rate by 2.3 %, as compared to the tax rate without such benefits. Net income Six months ended June 30, Change 2020 vs. 2019 % of Revenue (amounts in thousands) 2020 2019 $ % 2020 2019 Net income $ 991 $ 15,462 $ (14,471 ) -93.6 % 0.6 % 8.1 % Net income decreased $14.5 million for the six months ended June 30, 2020 from the six months ended June 30, 2019, or a decrease of 93.6% from the comparable period. The decrease in net income was primarily related to lower sales revenue and gross margin as well as a higher effective tax rate, partially offset by lower operating expenses. Contractual obligations We obtain individual components for our products from a wide variety of individual suppliers. Consistent with industry practice, we acquire components through a combination of purchase orders, supplier contracts, and open orders based on projected demand information. Where appropriate, the purchases are applied to inventory component prepayments that are outstanding with the respective supplier. As of June 30, 2020, we had purchase obligations with outside vendors and suppliers of approximately $68.2 million of which the timing varies depending on demand, current supply on hand and other factors. The obligations normally do not extend beyond twelve-month time frames. Except as indicated above, there have been no other material changes, outside of the ordinary course of business, in our outstanding contractual obligations from those disclosed within “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section contained in our Annual Report on Form 10-K filed with the SEC on February 25, 2020. Off-balance sheet arrangements We do not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or for any other contractually narrow or limited purpose. However, from time-to-time, we enter into certain types of contracts that contingently require us to indemnify parties against third-party claims including certain real estate leases, supply purchase agreements, and directors and officers. The terms of such obligations vary by contract and in most instances a maximum dollar amount is not explicitly stated therein. Generally, amounts under these contracts cannot be reasonably estimated until a specific claim is asserted thus no liabilities have been recorded for these obligations on our balance sheets for any of the periods presented. Liquidity and capital resources As of June 30, 2020, we had cash and cash equivalents of $214.1 million, which consisted of highly-liquid investments with a maturity of three months or less. Since inception, we have received net proceeds of $91.7 million from the issuance of redeemable convertible preferred stock and convertible preferred stock and $52.5 million ($49.7 million net proceeds) in connection with the sale of common stock in our initial public offering. Since 2013, we have received $52.4 million from proceeds related to stock option exercises and our employee stock purchase plan. For the six months ended June 30, 2020 and June 30, 2019, we received $1.3 million and $3.4 million, respectively, in proceeds related to these stock programs. Our principal uses of cash for liquidity and capital resources in the six months ended June 30, 2020 consisted of capital expenditures of $5.6 million including additional rental equipment and other property, plant and equipment. The COVID-19 PHE did not yet materially impact our liquidity position to date, and we believe our current cash and cash equivalents provide us with a certain degree of stability and liquidity during this time of uncertainty. We believe that our current cash, cash equivalents and the cash to be generated from expected product sales and rentals will be sufficient to meet our projected operating and investing requirements for at least the next twelve months. However, our liquidity assumptions may prove to be incorrect, and we could utilize our available financial resources sooner than we currently expect. Our future funding requirements will depend on many factors, including market acceptance of our products; the cost of our research and development activities; payments 48 from customers; the cost, timing, and outcome of litigation or disputes involving intellectual property rights, our products, employee relations, cyber security incidents, or otherwise; the cost and timing of acquisitions; the cost and timing of regulatory clearances or approvals; the cost and timing of establishing additional sales, marketing, and distribution capabilities; and the effect of competing technological and market developments. In the future, we may acquire businesses or technologies from third parties, and we may decide to raise additional capital through debt or equity financing to the extent we believe this is necessary to successfully complete these acquisitions. Our future capital requirements will also depend on many additional factors, including those set forth in the section of this Quarterly Report on Form 10- Q entitled “Risk Factors.” If we require additional funds in the future, we may not be able to obtain such funds on acceptable terms, or at all. In the future, we may also attempt to raise additional capital through the sale of equity securities or through equity-linked or debt financing arrangements. If we raise additional funds by issuing equity or equity-linked securities, the ownership of our existing stockholders will be diluted. If we raise additional financing by the incurrence of indebtedness, we will be subject to increased fixed payment obligations and could also be subject to restrictive covenants, such as limitations on our ability to incur additional debt, and other operating restrictions that could adversely impact our ability to conduct our business. Any future indebtedness we incur may result in terms that could be unfavorable to equity investors. There can be no assurances that we will be able to raise additional capital, which would adversely affect our ability to achieve our business objectives. In addition, if our operating performance during the next twelve months is below our expectations, our liquidity and ability to operate our business could be adversely affected. The following tables show a summary of our cash flows and working capital for the periods and as of the dates indicated: Six months ended (amounts in thousands) June 30, Change 2020 vs. 2019 Summary of consolidated cash flows 2020 2019 $ % Cash provided by operating activities $ 14,070 $ 16,603 $ (2,533 ) -15.3 % Cash provided by (used in) investing activities 851 (1,832 ) 2,683 146.5 % Cash provided by financing activities 1,036 2,618 (1,582 ) -60.4 % Effect of exchange rates on cash 92 (76 ) 168 221.1 % Net increase in cash and cash equivalents $ 16,049 $ 17,313 $ (1,264 ) -7.3 % (amounts in thousands) June 30, December 31, Working capital 2020 2019 Cash and cash equivalents $ 214,086 $ 198,037 Marketable securities 4,549 11,057 Accounts receivable, net 28,422 34,325 Inventories, net 36,180 35,664 Income tax receivable 2,984 2,976 Prepaid expenses and other current assets 16,544 10,160 Total current assets 302,765 292,219 Accounts payable and accrued expenses 29,363 30,730 Accrued payroll 6,405 6,215 Warranty reserve - current 5,769 4,923 Operating lease liability - current 1,823 2,014 Deferred revenue - current 6,266 5,478 Income tax payable 988 821 Total current liabilities 50,614 50,181 Net working capital $ 252,151 $ 242,038 Operating activities We derive operating cash flows from cash collected from the sales and rental of our products and services. These cash flows received are partially offset by our use of cash for operating expenses to support the growth of our business. Net cash provided by operating activities for the six months ended June 30, 2020 consisted primarily of our net income of $1.0 million as well as non-cash expense items such as depreciation of equipment and leasehold improvements and amortization of our intangibles of $8.9 million, provision for sales returns and doubtful accounts of $5.7 million, stock-based compensation expense of $4.1 million, provision for rental revenue adjustments of $1.5 million, decrease in deferred tax assets of $0.7 million, and provision for 49 inventory obsolescence and other inventory losses of $0.6 million . T he net changes in operating assets and liabilities resulted in a net use of cash of $ 8.7 million . Net cash provided by operating activities for the six months ended June 30, 2019 consisted primarily of our net income of $15.5 million as well as non-cash expense items such as provision for sales returns and doubtful accounts of $8.9 million, depreciation of equipment and leasehold improvements and amortization of our intangibles of $5.6 million, stock-based compensation expense of $5.4 million, a decrease in deferred tax assets of $4.1 million, provision for rental revenue adjustments of $1.2 million, and provision for inventory obsolescence and other inventory losses of $0.4 million. The net changes in operating assets and liabilities resulted in a net use of cash of $24.6 million. Investing activities Net cash provided by (used in) investing activities for each of the periods presented included cash used for acquisitions and in the production and purchase of rental assets, manufacturing tooling, and computer equipment and software to support our expanding business as well as net (purchases) maturities of marketable securities. For the six months ended June 30, 2020, we received $11.1 million in maturities of marketable securities, partially offset by $4.6 million in purchases of marketable securities. In addition, we invested $5.8 million in the production and purchase of rental assets and other property, equipment, and intangible assets. For the six months ended June 30, 2019, we invested $38.6 million in corporate bonds and U.S. Treasury securities with maturities greater than three months that were classified as marketable securities, partially offset by $40.2 million in maturities of marketable securities. In addition, we invested $3.4 million in the production and purchase of rental assets and other property, equipment, and leasehold improvements. We expect to continue investing in property, equipment and leasehold improvements as we expand our operations. Our business is inherently capital intensive. For example, we expend significant manufacturing and production expense in connection with the development and production of our oxygen concentrator products and, in connection with our rental business, we incur expense in the deployment of rental equipment to our patients. Investments will continue to be required in order to grow our sales and rental revenue and continue to supply and replace rental equipment to our rental patients on service. Financing activities Historically, we have funded our operations through our sales and rental revenue, the issuance of preferred and common stock, and the incurrence of indebtedness. For the six months ended June 30, 2020, net cash provided by financing activities consisted of $1.3 million from purchases under our employee stock purchase program and the proceeds received from stock options that were exercised, partially offset by the payment of employment taxes related to the vesting of restricted stock awards and restricted stock units of $0.2 million. For the six months ended June 30, 2019, net cash provided by financing activities consisted of $3.4 million from the proceeds received from stock options that were exercised and purchases under our employee stock purchase program, partially offset by the payment of employment taxes related to the vesting of restricted stock awards and restricted stock units of $0.8 million. Sources of funds Our cash provided by operating activities in the six months ended June 30, 2020 was $14.1 million compared to $16.6 million in the six months ended June 30, 2019. As of June 30, 2020, we had cash and cash equivalents of $214.1 million. Use of funds Our principal uses of cash are funding our new rental asset deployments and other capital purchases, operations, and other working capital requirements and, from time-to-time, the acquisition of businesses. Over the past several years, our revenue has increased from year-to-year and, as a result, our cash flows from customer collections have increased as have our profits. Our annual cash provided by operating activities has generally increased over time and has been a significant source of capital to the business, which we expect to continue in the future. We may need to raise additional funds to support our investing operations, and such funding may not be available to us on acceptable terms, or at all. If we are unable to raise additional funds when needed, our operations and ability to execute our business strategy could be adversely affected. We may seek to raise additional funds through equity, equity-linked or debt financings. If we 50 raise additional funds through the incurrence of indebtedness, such indebtedness would have rights that are senior to holders of our equity securities and could contain covenants that restrict our operations. Any additional equity financing may be dilutive to our stockholders. Non-GAAP financial measures EBITDA and Adjusted EBITDA are financial measures that are not calculated in accordance with U.S. GAAP. We define EBITDA as net income excluding interest income, interest expense, taxes and depreciation and amortization. Adjusted EBITDA also excludes stock-based compensation and change in fair value of earnout liability. Below, we have provided a reconciliation of EBITDA and Adjusted EBITDA to our net income, the most directly comparable financial measure calculated and presented in accordance with U.S. GAAP. EBITDA and Adjusted EBITDA should not be considered alternatives to net income or any other measure of financial performance calculated and presented in accordance with U.S. GAAP. Our EBITDA and Adjusted EBITDA may not be comparable to similarly titled measures of other organizations because other organizations may not calculate EBITDA and Adjusted EBITDA in the same manner as we calculate these measures. We include EBITDA and Adjusted EBITDA in this Quarterly Report on Form 10-Q because they are important measures upon which our management assesses our operating performance. We use EBITDA and Adjusted EBITDA as key performance measures because we believe they facilitate operating performance comparisons from period-to-period by excluding potential differences primarily caused by variations in capital structures, tax positions, the impact of depreciation and amortization expense on our fixed assets and intangible assets, the impact of stock-based compensation expense and the impact of the change in fair value of the earnout liability. Because EBITDA and Adjusted EBITDA facilitate internal comparisons of our historical operating performance on a more consistent basis, we also use EBITDA and Adjusted EBITDA for business planning purposes, to incentivize and compensate our management personnel, and in evaluating acquisition opportunities. In addition, we believe EBITDA and Adjusted EBITDA and similar measures are widely used by investors, securities analysts, ratings agencies, and other parties in evaluating companies in our industry as a measure of financial performance and debt-service capabilities. Our uses of EBITDA and Adjusted EBITDA have limitations as analytical tools and should not be considered in isolation or as a substitute for analysis of our results as reported under U.S. GAAP. Some of these limitations are: • EBITDA and Adjusted EBITDA do not reflect our cash expenditures for capital equipment or other contractual commitments; • although depreciation and amortization are non-cash charges, the assets being depreciated and amortized may have to be replaced in the future, and EBITDA and Adjusted EBITDA do not reflect capital expenditure requirements for such replacements; • EBITDA and Adjusted EBITDA do not reflect changes in, or cash requirements for, our working capital needs; • Adjusted EBITDA does not include changes in fair value of earnout liability related to our acquisitions; and • other companies, including companies in our industry, may calculate EBITDA and Adjusted EBITDA measures differently, which reduces their usefulness as a comparative measure. In evaluating EBITDA and Adjusted EBITDA, we anticipate that in the future we will incur expenses within these categories similar to this presentation. Our presentation of EBITDA and Adjusted EBITDA should not be construed as an inference that our future results will be unaffected by certain expenses. When evaluating our performance, EBITDA and Adjusted EBITDA should be considered alongside other financial performance measures, including U.S. GAAP results. 51 The following table present s a reconciliation of EBITDA and Adjusted EBITDA to our net income , the most comparable U.S. GAAP measure, for each of the periods indicated: (amounts in thousands) Three months ended June 30, Six months ended June 30, Non-GAAP EBITDA and Adjusted EBITDA 2020 2019 2020 2019 Net income $ 2,580 $ 10,160 $ 991 $ 15,462 Non-GAAP adjustments: Interest income (176 ) (1,394 ) (728 ) (2,728 ) Provision for income taxes 945 3,524 847 4,294 Depreciation and amortization 4,480 2,760 8,942 5,554 EBITDA (non-GAAP) 7,829 15,050 10,052 22,582 Stock-based compensation 1,277 1,779 4,061 5,365 Change in fair value of earnout liability 932 — (20 ) — Adjusted EBITDA (non-GAAP) $ 10,038 $ 16,829 $ 14,093 $ 27,947