Pulmonx Corp - Annual Report: 2020 (Form 10-K)
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
☒ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
For the fiscal year ended December 31, 2020
OR
| ☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | ||||
Commission File Number 001-39562 | |||||
PULMONX CORPORATION
(Exact name of registrant as specified in its charter)
Delaware | 77-0424412 | |||||||
(State or other jurisdiction of incorporation or organization) | (I.R.S. Employer Identification Number) | |||||||
700 Chesapeake Drive
Redwood City, California 94063
1-650-364-0400
(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| Common Stock, $0.001 par value per share | LUNG | The Nasdaq Stock Market LLC | ||||||
Securities registered pursuant to section 12(g) of the Act: None
Indicate by check mark if the registrant is a well‑known seasoned issuer, as defined in Rule 405 of the Securities Act. ☐ Yes ☒ No
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ☐ Yes ☒ No
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. ☒ Yes ☐ No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S‑T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). ☒ Yes ☐ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
| Large accelerated filer | ☐ | Accelerated filer | ☐ | |||||||||||
| Non-accelerated filer | ☒ | Smaller reporting company | ☒ | |||||||||||
| Emerging growth company | ☒ | |||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒
Indicate by check mark whether the Registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). ☐ Yes ☒ No
As of March 4, 2021 there were 35,689,881 shares of the Registrant’s Common Stock, par value $0.001 per share, outstanding.
The Registrant was not a public company as of the last business day of its most recently completed second fiscal quarter and, therefore, cannot calculate the aggregate market value of its voting equity held by non-affiliates as of such date.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the registrant’s definitive proxy statement relating to its 2021 annual meeting of stockholders (the “2021 Proxy Statement”) are incorporated by reference into Part III of this Annual Report on Form 10-K where indicated. The 2021 Proxy Statement will be filed with the U.S. Securities and Exchange Commission within 120 days after the end of the fiscal year to which this Annual Report on Form 10-K relates.
TABLE OF CONTENTS
| Page | |||||
| PART I | |||||
| PART II | |||||
| PART III | |||||
| PART IV | |||||
SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS
This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended, or Exchange Act. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends affecting the financial condition of our business. Forward-looking statements should not be read as a guarantee of future performance or results, and will not necessarily be accurate indications of the times at, or by, which such performance or results will be achieved. Forward-looking statements are based on information available at the time those statements are made and/or management’s good faith beliefs as of that time with respect to future events, and are subject to risks and uncertainties that could cause actual performance or results to differ materially from those expressed in or suggested by the forward-looking statements.
Forward-looking statements include all statements that are not historical facts. In some cases, you can identify forward-looking statements by terms such as “may,” “might,” “will,” “objective,” “intend,” “should,” “could,” “can,” “would,” “expect,” “believe,” “anticipate,” “project,” “target,” “design,” “estimate,” “predict,” “potential,” “plan” or the negative of these terms, or similar expressions and comparable terminology intended to identify forward-looking statements. These statements reflect our current views with respect to future events and are based on assumptions and subject to risks and uncertainties, including those set forth in Part I, Item 1A “Risk Factors” and elsewhere in this Annual Report on Form 10-K. Forward-looking statements include, but are not limited to, statements about:
•our ability to design, develop, manufacture and market innovative products to treat patients with challenging medical conditions, particularly those with COPD and emphysema;
•our expectations regarding the impact of the COVID-19 pandemic on our business;
•our expected future growth, including growth in international sales;
•our expected future growth of our sales and marketing organization;
•the size and growth potential of the markets for our products, and our ability to serve those markets;
•the rate and degree of market acceptance of our products;
•coverage and reimbursement for procedures performed using our products;
•the performance of third parties in connection with the development of our products, including third-party suppliers;
•regulatory developments in the United States and foreign countries;
•our ability to obtain and maintain regulatory approval or clearance of our products on expected timelines;
•our plans to research, develop and commercialize our products and any other approved or cleared product;
•our ability to retain and hire our senior management and other highly qualified personnel;
•the development, regulatory approval, efficacy and commercialization of competing products and technologies in our industry;
•our expectations regarding the period during which we qualify as an emerging growth company under the JOBS Act;
•our ability to develop and maintain our corporate infrastructure, including our internal controls;
•our financial performance and capital requirements; and
•our expectations regarding our ability to obtain and maintain intellectual property protection for our products, as well as our ability to operate our business without infringing the intellectual property rights of others.
All forward-looking statements are based on information available to us on the date of this Annual Report on Form 10-K and we will not update any of the forward-looking statements after the date of this Annual Report on Form 10-K, except as required by law. Our actual results could differ materially from those discussed in this Annual Report on Form 10-K. The forward-looking statements contained in this Annual Report on Form 10-K, and other written and oral forward-looking statements made by us from time to time, are subject to certain risks and uncertainties that could cause actual results to differ materially from those anticipated in the forward- looking statements, and you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. Factors that might cause such a difference include, but are not limited to, those discussed in the following discussion and within Part I, Item 1A, “Risk Factors” of this Annual Report on Form 10-K.
In addition, statements that “we believe” and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Annual Report on Form 10-K, and although we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted a thorough inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements.
All brand names or trademarks appearing in this Annual Report on Form 10-K are the property of their respective holders. Unless the context requires otherwise, references in this Annual Report on Form 10-K to “Pulmonx” the “Company,” “we,” “us,” and “our” refer to Pulmonx Corporation.
Risk Factors Summary
Below is a summary of the principal factors that make an investment in our common stock speculative or risky. Importantly, this summary does not address all the risks and uncertainties that we face. Additional discussion of the risks and uncertainties summarized in this risk factor summary, as well as other risks and uncertainties that we face, can be found under “Special Note Regarding Forward-Looking Statement” and Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K. The below summary is qualified in its entirety by those more complete discussions of such risks and uncertainties. You should consider carefully the risks and uncertainties described under Part I, Item 1A, “Risk Factors” in this Annual Report on Form 10-K as part of your evaluation of an investment in our common stock:
•We have a history of significant net losses, which we expect to continue, and we may not be able to achieve or sustain profitability in the future;
•We have limited experience marketing and selling our solution;
•We currently rely on a single product, the Zephyr Valve, which can only be marketed for limited indications, and if we are not successful in commercializing the Zephyr Valve, our business, financial condition and results of operations will be negatively affected;
•Our business is dependent on hospital, physician and patient adoption of our solution as a treatment for severe emphysema. If hospitals, physicians or patients are unwilling to change current practices to adopt our solution, it will negatively affect our business, financial condition and results of operations;
•If we fail to receive access to hospital facilities our sales may decrease;
•A pandemic, epidemic or outbreak of an infectious disease in the United States or worldwide, including the outbreak of the novel strain of coronavirus disease, COVID-19, has adversely affected our business;
•Use of the Zephyr Valve involves risks and may result in complications, including pneumothorax or death, and is contraindicated in certain patients, which may limit adoption and negatively affect our business, financial condition and results of operations;
•If we are unable to achieve and maintain adequate levels of coverage or reimbursement for our solution, or any future products we may seek to commercialize, or if patients are left with significant out-of-pocket costs, our commercial success may be severely hindered;
•If we fail to retain marketing and sales personnel and, as we grow, fail to increase our marketing and sales capabilities or develop broad awareness of our solution in a cost-effective manner, we may not be able to generate revenue growth;
•We have limited long-term data regarding the safety and effectiveness of our solution, including the Zephyr Valve. The only safety and effectiveness data of our solution, including the Zephyr Valve, is limited to one year following placement and we are required to conduct extension studies to follow up on safety and effectiveness out to five years;
•We have limited experience manufacturing our products in significant commercial quantities and we face manufacturing risks that may adversely affect our ability to manufacture our products, reduce our gross margins and negatively affect our business, financial condition and results of operations;
•Our operating results may fluctuate significantly, which makes our future operating results difficult to predict and could cause our operating results to fall below expectations or any guidance we may provide;
•The sizes of the markets for our current and future products have not been established with precision and may be smaller than we estimate and may decline. Certain patients may not have regions of the lung with little to no collateral ventilation, making them poor candidates for the Zephyr Valve. In addition, if the overall rate of smokers continues to decline, this may eventually decrease the number of patients suffering from COPD and emphysema and, accordingly, who would benefit from our solution;
•We expect to continue to incur net losses for the next several years and we expect to require substantial additional capital to finance our planned operations, which may include future equity and debt financings. This additional capital may not be available to us on acceptable terms or at all. Our failure to obtain additional financing when needed on acceptable terms, or at all, could force us to delay, limit, reduce or eliminate our commercialization, sales and marketing efforts, product development programs or other operations;
•Our products and operations are subject to extensive government regulation and oversight both in the United States and abroad. If we fail to obtain and maintain necessary regulatory approvals for the Zephyr Valve and related products, or if approvals for future products and indications are delayed or not issued, it will negatively affect our business, financial condition and results of operations; and
•We may become a party to intellectual property litigation or administrative proceedings that could be costly and could interfere with our ability to sell and market our products.
PART I
ITEM 1. BUSINESS
Overview
We are a commercial-stage medical technology company that provides a minimally invasive treatment for patients with severe emphysema, a form of chronic obstructive pulmonary disease (COPD). Our solution, which is comprised of the Zephyr Endobronchial Valve (Zephyr Valve), the Chartis Pulmonary Assessment System (Chartis System) and the StratX Lung Analysis Platform (StratX Platform), is designed to treat severe emphysema patients who, despite medical management, are still profoundly symptomatic and either do not want or are ineligible for surgical approaches. We estimate our solution currently addresses approximately 500,000 patients in the United States and 700,000 patients in select international markets, which represents a global market opportunity of approximately $12 billion.
We have a compelling body of clinical evidence with over 100 scientific articles published regarding the clinical benefits of Zephyr Valves, including in The New England Journal of Medicine, The Lancet and the American Journal of Respiratory and Critical Care Medicine. Multiple randomized controlled clinical trials have demonstrated that patients selected with the Chartis System and successfully treated with Zephyr Valves have shown statistically and clinically significant improvements in lung function, exercise capacity and quality of life compared to medical management alone.
In June 2018, we received pre-market approval (PMA) by the U.S. Food and Drug Administration (FDA) as a result of our breakthrough technology designation. The Zephyr Valve is now commercially available in more than 25 countries, with over 80,000 valves used to treat more than 20,000 patients. We have established reimbursement in major markets in North America, Europe and Asia Pacific and the Zephyr Valve has been included in treatment guidelines for COPD worldwide.
There are several treatment options for patients with emphysema, depending on the level of severity of the disease, ranging from medical management to more invasive surgical options. However, these treatment options have significant limitations for patients with severe emphysema.
Initial treatment for emphysema is generally limited to medications that primarily target airway obstruction and reduce inflammation, but do not address the underlying lung tissue destruction. As the disease worsens, symptoms increase despite optimized drug therapy, pulmonary rehabilitation exercises and supplemental oxygen.
As patients enter the severe phase, many become increasingly unable to engage in the most basic daily activities as a result of the persistent feeling of breathlessness and this reduces their overall health status each year. At this point, physicians may refer patients to thoracic surgeons for single or double lung transplantation or for lung volume reduction surgery (LVRS), in which hyperinflated tissue is cut away and removed. These invasive surgical
6
procedures involve substantial risk of complications, prolonged hospital stays and high mortality. In addition, many patients do not qualify for these procedures. Patients with severe emphysema generally experience a worse quality of life than patients with lung cancer. We believe there is both an urgent clinical need and a strong market opportunity for a solution that is safe, effective and minimally invasive.
Our solution, which is comprised of the Zephyr Valve, Chartis System and StratX Platform, is designed to address the need for a more effective, minimally invasive treatment option for patients with severe emphysema, offering bronchoscopic lung volume reduction without surgery and its associated risks. Zephyr Valves are indicated for bronchoscopic treatment of adult patients with hyperinflation associated with severe emphysema in regions of the lung that have little to no collateral ventilation. During the one-time bronchoscopic procedure, Zephyr Valves are placed in the airways to occlude the most diseased parts of the lung, allowing trapped air to escape until the lobe is reduced in size. The intended result is a reduction in lung volume and hyperinflation in the targeted lobe, allowing healthier parts of the lung to expand and take in more air. Patients who are successfully treated with the Zephyr Valve report improved breathing and the ability to go back to doing everyday tasks more easily.
We believe our solution provides the following important benefits:
•Significant, durable improvements in lung function, exercise capacity and quality of life, demonstrated in a substantial body of clinical data;
•Well-characterized safety profile, evidenced by the inclusion in global treatment recommendations and more than 20,000 patients treated globally with the Zephyr Valve;
•High procedural success driven by innovative and effective patient assessment tools; and
•Minimally invasive procedure typically lasting less than an hour.
Over 100 scientific articles have been published regarding the clinical benefits of Zephyr Valves, including multiple meta-analyses, review articles, cost-effectiveness analyses and risk-benefit analyses. The Zephyr Valve showed statistically significant improvements in lung function, exercise capacity and quality of life when compared to medical management alone in multiple randomized controlled clinical trials. Additionally, independent studies have demonstrated that Zephyr Valves deliver increases in the BODE Index (a multi-dimensional health status scoring system for patients with COPD) that have been associated with survival benefits.
The LIBERATE study, our pivotal study published in 2018, was a multicenter, multinational, randomized controlled clinical trial of Zephyr Valves that included 190 patients with severe emphysema and little to no collateral ventilation. All primary and secondary endpoints were statistically significant, including the proportion of patients achieving a clinically significant improvement in lung function as well as the mean improvements in exercise capacity, hyperinflation and quality of life. These outcomes were the result of a high rate of procedural success, with 84% of patients achieving a clinically meaningful reduction in treated lobe volume.
We market and sell our products in the United States through a direct sales organization. Our sales territory managers are focused on promoting awareness and increasing adoption of our solution primarily among the approximately 800 pulmonologists performing interventional pulmonary procedures and across approximately 500 high volume hospitals in the United States. We are expanding our commercial operations in the United States while continuing to foster our international growth. In international markets, we employ both direct and distributor-based sales models, with over 90% of our revenue generated in markets where we sell directly.
In the United States, our solution is reimbursed based on established Category I CPT and ICD-10 Procedure Coding System (PCS) codes and associated APC and MS-DRG payment groupings. Current reimbursement in the United States is believed to cover the hospital costs of the procedure and related inpatient care. Commercial payors such as Aetna, Humana, Health Care Service Corporation, and Highmark have issued positive coverage policies for the Zephyr Valve, and United Healthcare no longer considers the procedure unproven or experimental. Medicare covers our solution for patients when medically necessary, and other commercial insurers are approving pre-authorization
7
requests on a case-by-case basis. Outside the United States, our solution is covered by major health systems across much of Europe, Australia and South Korea.
We generated revenue of $32.7 million, with a gross margin of 64.8% and a net loss of $32.2 million, for the year ended December 31, 2020 compared to revenue of $32.6 million, with a gross margin of 68.8% and a net loss of $20.7 million, for the year ended December 31, 2019. As of December 31, 2020, we had an accumulated deficit of $242.7 million. We currently generate most of our revenue from the sales of Zephyr Valves and delivery catheters. We also generate a smaller amount of our revenue from our Chartis System, which is comprised of sales of the balloon catheters, usage fees and sales of the Chartis console. The StratX Platform, while used to identify patients eligible for treatment with Zephyr Valves, does not independently generate any revenue for us.
Our Market Opportunity
Overview of COPD and Emphysema
COPD refers to a group of lung diseases characterized by obstruction of airflow that interferes with normal breathing. In 2015, it affected approximately 175 million patients and was responsible for 3.2 million deaths globally. We estimate that there are approximately 8.5 million severe COPD patients in developed markets globally as of 2019. In the United States, COPD is the third leading cause of death and affected approximately 16 million Americans as of 2013.
Emphysema, a form of COPD, which accounts for approximately 25% of all COPD patients, is a debilitating and life-threatening disease that progressively destroys lung tissue, resulting in a diminishing ability to breathe and engage in the most basic daily activities, leading to a high mortality rate. Of the approximately 8.5 million global severe COPD patients, we estimate approximately 3.2 million have severe emphysema and approximately 5 million have severe chronic bronchitis. Of the approximately 3.2 million severe emphysema patients, we estimate that approximately 1.2 million may be eligible for treatment with Zephyr Valves, and an additional number may be able to be treated in the future with other technologies under development by us. We estimate this represents a global market opportunity of approximately $12 billion.
As of 2018, approximately 3.8 million patients in the United States were diagnosed with emphysema, of which roughly 1.5 million have severe emphysema. Of these 1.5 million severe emphysema patients, we estimate that approximately 500,000 patients would qualify for treatment with our Zephyr Valves, and an additional number may be able to be treated in the future with other technologies under development by us if successfully developed and approved. We estimate this represents a U.S. market opportunity of approximately $5 billion.
The lung damage caused by emphysema is irreversible. In patients with emphysema, diseased portions of the lung lose their ability to exchange oxygen and carbon dioxide due to damage to the air sacs, or alveoli. The diseased portions of the lung also lose elasticity, become over-inflated, and crowd out the healthier lung tissue. As a result, patients with emphysema experience shortness of breath, gradually losing their ability to engage in the most basic daily activities such as climbing a flight of stairs, walking or showering. Based on published literature, the five-year mortality rate for patients with severe emphysema is approximately 50%.
8
The following graph shows an increased mortality rate for patients with more hyperinflation relative to patients with less hyperinflation.
The inspiratory capacity-to-total-lung capacity (IC/TLC) ratio is an indirect measurement of lung hyperinflation. The graph above depicts two Kaplan-Meier survival analyses of (1) patients with an IC/TLC ratio greater than 25% and (2) patients with an IC/TLC less than or equal to 25%.
Emphysema is diagnosed through a combination of breathing tests and computed tomography (CT) imaging of the lungs. The diagnosis is typically done by a radiologist or a pulmonologist. Emphysema severity is evaluated using a standardized test called spirometry as well as the degree of patient symptoms.
Current Treatments for Emphysema and Their Limitations
There are several treatment options for patients with emphysema, depending on the level of severity of the disease, ranging from medical management to surgery. However, these treatment alternatives have significant limitations and in some cases are highly invasive.
Initial treatment for emphysema is generally limited to prescribing inhaled medications such as drugs that open the airways and reduce inflammation, which primarily target airway obstruction. However, as the disease becomes more severe, the effectiveness of drug therapy is diminished, and patients feel increasingly breathless. As the disease progresses, physicians may prescribe pulmonary rehabilitation exercises and supplemental oxygen, but these can be poorly tolerated by patients and often lose effectiveness with time. As patients enter the severe phase, many become increasingly unable to engage in the most basic daily activities as a result of the persistent feeling of breathlessness and this reduces their overall health status each year. At this point, physicians may refer patients to thoracic surgeons for LVRS, in which hyperinflated tissue is cut away and removed, or for single or double lung transplantation.
LVRS is an invasive surgery that involves cutting away diseased tissue to create space for the remaining lung to more fully inflate. LVRS was studied extensively in the National Emphysema Treatment Trial (NETT), which showed that while a broad group of patients gained quality of life and exercise capacity from the surgery, it also involved substantial risks of complications, prolonged hospital stays and even death. As a result of the NETT study, use of LVRS was restricted by the Centers for Medicare & Medicaid Services (CMS) to a subgroup of patients and can only be offered at a limited number of highly specialized medical centers.
9
Lung transplantation involves surgically removing one or both lungs and replacing them with donor lungs. This procedure is highly time and resource intensive due to the complexity of the surgery. Even with a successful procedure and consistent use of anti-rejection medications, lung transplantation patients have a five-year survival rate on average. Due to these limitations, and constraints from limited donor supply, LVRS and lung transplantation combined have fewer than 2,000 procedures performed for COPD each year in the United States.
In addition to recently approved endobronchial valves, there are other approaches to a minimally invasive alternatives to LVRS, including the use of airway bypass, coils and vapor. However, to date, only endobronchial valves have demonstrated safety and effectiveness in FDA-approved investigational device exemption (IDE) studies in the United States.
Our Solution
Our solution, which is comprised of the Zephyr Valve, Chartis System and StratX Platform, is designed to treat severe emphysema patients who, despite medical management, are still profoundly symptomatic and either do not want or are ineligible for surgical approaches. Our solution is designed to address the need for a more effective, minimally invasive treatment option for patients with severe emphysema, offering bronchoscopic lung volume reduction without surgery and its associated risks.
Zephyr Valves are indicated for bronchoscopic treatment of adult patients with hyperinflation associated with severe emphysema in regions of the lung that have little to no collateral ventilation. During the one-time bronchoscopic procedure, Zephyr Valves are placed in the airways to occlude the most diseased parts of the lung, allowing trapped air to escape until the lobe is reduced in size. The intended result is a reduction in lung volume and hyperinflation in the targeted area, allowing healthier parts of the lung to expand and take in more air. Patients who are successfully treated with the Zephyr Valve report improved breathing and the ability to go back to doing everyday tasks more easily. When combined with the Chartis System for informed patient selection and treatment planning, Zephyr Valves have been shown to have successful procedure rates of 84-90% in clinical trials.
We believe our solution provides the following important benefits:
•Significant, durable improvements in lung function, exercise capacity and quality of life, demonstrated in a substantial body of clinical data;
•Well-characterized safety profile, evidenced by the inclusion in global treatment recommendations and more than 20,000 patients treated globally with Zephyr Valve;
•High procedural success driven by innovative and effective patient assessment tools; and
10
•Minimally invasive procedure typically lasting less than an hour.
In addition, we believe our solution provides several benefits to other key stakeholders:
•For hospitals, the Zephyr Valve represents a new service line with potential economic benefits, driving additional patients to their facilities. Patients who are evaluated require a comprehensive workup that may unveil other health conditions such as heart disease or cancer, which also may require treatment.
•For physicians, the Zephyr Valve enables treatment for a patient population with few alternatives, and the combination of using the StratX Platform and Chartis System are designed to enable a simple, predictable and efficient patient selection process.
•For payors, treatment with the Zephyr Valve has been demonstrated to result in fewer complications and quicker recovery than invasive surgical alternatives and may reduce hospital stays for COPD and incidence of respiratory failure. We believe the combination of using the StratX Platform and Chartis System enables selection and treatment of patients most likely to benefit from our solution.
Treatment with Zephyr Valves
Patient Selection and Treatment Planning
Patients with advanced COPD routinely undergo a thorough diagnostic workup, which typically includes a high-resolution CT scan of their lungs to determine if they have severe emphysema and hyperinflation. If the patient meets medical eligibility criteria for Zephyr Valves, their CT scan data will be uploaded to our secure cloud-based CT analysis service, the StratX Platform. The treating physician receives an easy-to-read report that we designed for our solution (StratX Lung Report) and based on the report, CT scan and other clinical data, decides if the patient is a good candidate for treatment with Zephyr Valves and which lobes may be the best target for treatment. On the day of the procedure, a flexible camera called a bronchoscope is inserted into the lungs, and using the balloon catheter and console comprising the Chartis System, the physician can determine the presence or absence of collateral ventilation and confirm if the target lobe is likely to respond to treatment. If the assessment shows that there is little to no collateral ventilation to the target lobe (which would refill the lobe with air and limit benefit from the valves), the physician then proceeds to place Zephyr Valves in all airways leading to the target lobe. If there is collateral ventilation in the lobe, the physician may measure another lobe for possible treatment, or decide not to treat the patient with valves.
Placement of the Zephyr Valves
The Zephyr Valve is typically implanted under general anesthesia or conscious sedation. Using our Endobronchial Delivery Catheter (EDC) in a simple, one-step process, physicians select the optimal valve size for each airway. The valves are loaded into the delivery catheter and deployed through the bronchoscope using a controlled release mechanism to enable optimal placement. We offer four valve sizes to accommodate a broad range of airway anatomy that physicians may encounter. Following placement of valves, the patient is kept in the hospital, typically for three nights, to monitor for any side effects including pneumothorax. If a patient develops a pneumothorax, their hospital stay is typically extended by a week.
Zephyr Valves
Each of the Zephyr Valves consists of a one-way silicone duckbill valve suspended inside a self-expanding frame made of shape-memory metal, called Nitinol. The Zephyr Valve is designed to be easily and accurately sized and offers controlled and accurate deployment at the target location. The Zephyr Valve is also designed to resist fractures or breakage, adapt to changes in airway size and stay in place following deployment.
11
The following diagram depicts the four sizes of Zephyr Valves (two different diameters and four lengths).
 | |||||||||||
| 4.0-LP EBV | 4.0 EBV | 5.5-LP EBV | 5.5 EBV | ||||||||
Physicians select the optimal valve size for each airway to be treated using an EDC that includes sizing wings and depth markers, which allows the physician to perform quick and accurate sizing.
The Zephyr Valve is then loaded into the EDC.
12
Zephyr Valves offer a controlled, stepwise deployment for easy and accurate placement in the target airway. Once deployed, the valve is held in place by the radial expansion force of the housing. Typically, multiple valves are used to obstruct all airways leading to the target lobe; in clinical studies, an average of four valves per patient were used.
 |  | ||||
 |  | ||||
Once the lobe is fully obstructed, air vents out of the treated lobe and is unable to re-enter, causing a reduction in hyperinflation. The treated lobe shrinks in volume over time, allowing the remaining portions of the lung to expand and to restore diaphragm position, making breathing easier.
 |  | ||||
The Zephyr Valve is designed to be a permanent implant, but unlike surgery, the procedure can be reversed if necessary.
The most common serious complications of treatment with Zephyr Valves can include pneumothorax, worsening of COPD symptoms, hemoptysis, pneumonia, dyspnea, respiratory failure and, in rare cases, death. See “Clinical Trials and Results” for a discussion of complications related to Zephyr Valve, including pneumothoraces and death.
13
StratX Platform
The StratX Platform is a cloud-based quantitative CT analysis service that provides physicians with an easy-to-read report that we designed for our solution (StratX Lung Report) that includes information on emphysema destruction, fissure completeness and lobar volume to help identify target lobes for treatment with Zephyr Valves. The StratX Platform is designed to enable physicians to:
•Screen treatment candidates non-invasively;
•Prioritize between multiple potential treatment targets, if applicable;
•Enhance case planning and optimize procedure time; and
•Educate themselves and their patients using the simple to read StratX Lung Report.
In order to make the StratX Platform available to physicians, we contract with a third-party cloud service provider. This third-party cloud service enables physicians to upload CT scan data while removing protected health information (PHI) of patients from that data, in case the physicians have, inadvertently, not removed the PHI themselves. We also contract with additional third-party service providers to analyze the CT scan data using their proprietary software, and provide quantitative results via the StratX Lung Report. The StratX Lung Report is then made available to physicians in the third-party cloud service. The software of each of these third-party service providers has received either 510(k) approval or a CE mark. We provide exclusive access to physicians to their StratX accounts and cases and monitor this CT scan upload and analysis process to ensure quality control.
14
A sample StratX Lung Report is below, with each section briefly described afterwards.
1.Summary Graphic: The goal of the Zephyr Valve treatment is to completely obstruct and reduce the volume of a target lobe, thereby reducing hyperinflation and improving breathing. In selecting a target lobe, physicians are instructed to look for higher levels of emphysema destruction and presence of complete or nearly complete fissures with neighboring lobes (which has been associated with absence of collateral ventilation and likely response to therapy). The StratX Lung Report contains tabulated data on fissure completeness by lobe, destruction score by lobe and lobar volume. An infographic “key” for easy interpretation of the data is also included. This infographic includes color coding representing the level of emphysema destruction (with darker colors representing lobes with more destruction) and different levels of fissure completeness relative to a target lobe (with darker and more complete lines having greater completeness).
2.Fissure Completeness: Fissure completeness has been shown to be a predictor of success and a surrogate for collateral ventilation between the target and the neighboring lobes. The StratX Lung Report displays fissure completeness values “by lobe,” meaning the values are computed as a percentage of the total area of the fissure across the lobar boundary. The value of fissure completeness between each lobar region is represented with a dark solid, light solid or dotted line. The dark solid line represents fissures that are ≥95% intact. The light solid line represents fissures that are 80-95% intact. The dotted line represents fissures that are <80% intact. A fissure completeness score of <80% indicates the likely presence of collateral ventilation in that lobe, indicating that the lobe should not be considered for treatment with Zephyr Valves.
15
For fissure completeness values of >80%, fissure completeness should be confirmed using the Chartis System to confirm lobe eligibility.
3.Emphysema Destruction Scoring: Lobar destruction values of greater than 50% at -910 Hounsfield Units (a measure of tissue density) have been commonly used as an inclusion criterion for various clinical trials of Zephyr Valve treatment. The StratX Lung Report also includes lobar destruction values using -950 Hounsfield Units. In the report and summary view, the degree of shading of a lobe and the numbers within the lobe represent the level of destruction. Lobes with less than 50% destruction are colored white and are usually not considered as potential targets for Zephyr Valve treatment.
4.Inspiratory Volume: The inspiratory volume represents the volume of each lobe in mL. The inspiratory volume can help to identify the lobes with the largest volume representing hyperinflation and ones that may be a good target for Zephyr Valve treatment.
To use the StratX Platform, users must have an account set up with us. After the physician captures a CT scan of the patient’s chest according to the StratX parameters, the CT scan is de-identified of patient information and the hospital staff uploads the CT scan to our secure encrypted server where it is analyzed using validated algorithms within the StratX Platform. The StratX Platform generates a report that is checked by a trained technician for accuracy and completeness and uploaded to the hospital’s account within two to three working days, where it can be downloaded and reviewed by the treating physician.
We continue to gather scan data and refine our algorithms in the StratX Platform. We believe that our high volume of reports and data are a source of durable competitive advantage.
Chartis Pulmonary Assessment System
The Chartis System is a proprietary balloon catheter and console system with flow and pressure sensors designed to assess the presence of collateral ventilation and to accurately predict responders to Zephyr Valve treatment. The Chartis System consists of a single-patient-use catheter with a central lumen and a balloon at its tip and a console to allow for the assessment of airflow in the targeted lobe.
16
When the balloon is inflated, the target lobe is blocked, and air can only escape through the catheter’s central lumen.
Airflow and pressure are displayed on the console of the Chartis System allowing for a measurement of collateral ventilation in the targeted lobe. The system works with spontaneous breathing or mechanical ventilation. If the flow of air leaving the occluded lobe is trending towards zero, there is likely no collateral ventilation in the target lobe and it can be successfully treated with Zephyr Valves. By contrast, if the measurement shows continuous airflow from the lobe, the lobe is being refilled through collateral air channels and will likely not respond to Zephyr Valve treatment.
 |  | ||||
The Chartis System has been validated in multiple randomized controlled clinical trials to predict likely responders to the Zephyr Valve treatment.
The Chartis System offers a physiologic technique for measuring collateral ventilation and complements non-invasive estimates of fissure completeness. Other methods, such as using fissure analysis as a proxy measurement of collateral ventilation allows detection of an incomplete boundary between the lobes but does not measure how much air is flowing across this gap. Without assessment by the Chartis System, physicians may treat a lobe that has collateral ventilation, which will likely not respond to valve treatment, or unnecessarily rule out a patient who could have potentially benefitted from valve treatment.
For example, in one early study not sponsored by us that treated patients with a broad range of fissure completeness, approximately 60% of patients who had fissure completeness of 80-90% in the treated lobe had a successful procedure. If a physician was using only quantitative computed tomography (QCT) and a 90% fissure completeness cutoff to select patients, the physician would inappropriately screen out patients in the 80-90% completeness range that could benefit from valve treatment. In that same study, only 72% of patients with a fissure completeness of 90-100% had successful volume reduction in the target lobe. By comparison, patients selected using the Chartis System in four randomized controlled clinical trials had a success rate of 84%, 88%, 89% and 90%. Thus, while
17
quantitative fissure analysis is an important tool for non-invasively screening out ineligible lobes, we believe it is insufficient for identifying responders to treatment with high accuracy.
Treatment Steps
The following graphic illustrates the typical treatment steps associated with our solution.
Clinical Trials and Results
The safety, effectiveness and clinical benefits of the Zephyr Valve in patients selected using the Chartis System have been evaluated in multiple randomized controlled clinical trials that have collectively evaluated approximately 450 patients in Austria, Belgium, Brazil, France, Germany, the Netherlands, Sweden, the United Kingdom and the United States. The results of our LIBERATE study, which served as the basis for the FDA approval of our PMA application, were published in the American Journal of Respiratory and Critical Care Medicine in 2018 and met all its primary and secondary effectiveness endpoints. In addition, over 100 scientific articles have been published on the clinical benefits of Zephyr Valves, including multiple meta-analyses, review articles, cost-effectiveness analyses and risk-benefit analyses.
Four randomized controlled clinical trials using the Chartis System to select eligible patients (with little to no collateral ventilation) have been completed comparing the treatment of severe emphysema patients with Zephyr Valves with medical management versus medical management alone (which may include drug therapy, pulmonary rehabilitation and supplemental oxygen). All four studies demonstrated statistically and clinically significant benefits across a broad range of endpoints, including measures of lung function, exercise capacity, and quality of life. Patients who received the Zephyr Valve treatment together with medical management experienced increased lung function, a better quality of life and increased exercise capacity—they could walk farther, could do more daily life activities, such as walking, gardening, and getting ready in the morning, with less shortness of breath. This was due in part to the high rate of procedural success in deflating the target lobe of the lung, ranging from 84-90% in the studies. When the target lobe was properly occluded and isolated from airflow, trapped air in that lobe escaped only through the Zephyr Valves until the lobe volume was reduced. The remaining lobes were then able to expand more fully and work more efficiently, improving overall lung function. Additionally, studies have evaluated the impact of Zephyr Valves on the BODE Index, showing magnitudes of improvement that have been associated with survival benefits.
We are following patients enrolled in the LIBERATE study for up to five years for safety and effectiveness (FEV1) assessments. We have also established a patient registry to collect additional data on the safety and effectiveness of the Zephyr Valve (FEV1) in the United States. We have established a similar registry in France.
Summary of Key Clinical Results
18
As seen in the table below, the results from multiple randomized clinical trials have consistently shown statistically significant and clinically meaningful benefits of Zephyr Valves across multiple measures of effectiveness.
| Improvement in: | ||||||||||||||||||||||||||||||||
| Randomized Controlled Clinical Trials | Size and Follow-up Period | Procedural Success (TLVR %) | Lung Function (FEV1%) ┬ MCID = 10%-15% | Exercise Capacity (6MWD) ┬ MCID = 26 m | Quality of Life (SGRQ) ┬ MCID = -4 pts | |||||||||||||||||||||||||||
| LIBERATE | n = 190 12 Mo | 84% | 18.0% p<0.001 | 39 m p=0.002 | -7.1 pts p=0.004 | |||||||||||||||||||||||||||
| TRANSFORM | n = 97 6 Mo | 90% | 29.3 % p<0.001 | 79 m p<0.001 | -6.5 pts p=0.031 | |||||||||||||||||||||||||||
| IMPACT | n = 93 6 Mo | 89% | 16.3 % p<0.001** | 28 m p=0.016** | -7.5 pts p<0.001** | |||||||||||||||||||||||||||
| STELVIO | n = 68 6 Mo | 88% | 17.8 % P=0.001 | 74 m p<0.001 | -14.7 pts* P<0.001 | |||||||||||||||||||||||||||
_______________
┬ Difference between Zephyr Valve and control groups
* Per protocol, all other values listed are intention to treat (ITT)
** Data included in FDA-approved instructions for use (IFU)
The complications of treatment with Zephyr Valves can include but are not limited to pneumothorax, worsening of COPD symptoms, hemoptysis, pneumonia, dyspnea and, in rare cases, death. The most common side effect of Zephyr Valve placement is a pneumothorax, which is the collapse of a lung due to an air leak inside the lung. Pneumothoraces are believed to be a direct result of rapid shifts in air volume in the chest as the target lobe deflates and the neighboring lobe expands. A pneumothorax typically requires placement of a chest tube to manage the air leak. While most pneumothoraces can be readily managed with standard medical care, in rare cases they can be life-threatening, particularly if left untreated. In the event the pneumothorax does not resolve with standard management, one or more valves can be removed to re-inflate the lung; these are typically replaced later when the pneumothorax has resolved. In clinical trials, pneumothoraces occurred in 18-34% of patients treated with the Zephyr Valve, and in the LIBERATE Study, 17% of the pneumothorax events required no intervention and resolved on their own. Patients who have had their pneumothoraces successfully treated had comparable outcomes to those who did not experience a pneumothorax, other than that their hospital stays were extended by approximately a week compared to the three nights for patients without pneumothoraces.
Further, our current products are contraindicated, and therefore should not be used, in certain patients, including patients (i) for whom bronchoscopic procedures are contraindicated, (ii) with evidence of active pulmonary infection, (iii) with known allergies to Nitinol (nickel-titanium) or its constituent metals (nickel or titanium) or silicone, (iv) who have not quit smoking or (v) with large bullae encompassing greater than 30% of either lung.
Summary of the LIBERATE Study (Pivotal IDE Study)
LIBERATE, our pivotal study, was a multicenter, multinational, randomized controlled trial of Zephyr Valves in patients with heterogeneous emphysema and little to no collateral ventilation. The study was conducted between October 2013 and September 2017, and the results were published in May 2018 in the American Journal of Respiratory and Critical Care Medicine.
Key inclusion criteria were emphysema patients with heterogeneous disease (≥15 difference in destruction scores between the target and adjacent lobes), ex-smokers between 40 and 75 years of age, with post-bronchodilator (BD) forced expiratory volume in one second (FEV1) between 15% and 45% predicted, Total Lung Capacity (TLC) greater than 100% predicted, residual volume (RV) equal to or greater than 175% predicted, diffuse capacity of the lung for carbon monoxide equal to or greater than 20% predicted, a Six-Minute Walk Distance (6MWD) between 100 and 500 meters after a supervised pulmonary rehabilitation program and little to no collateral ventilation. Patients with two or more COPD exacerbations requiring hospitalization in the last year, two or more instances of
19
pneumonia in the last year, uncontrolled pulmonary hypertension, myocardial infarction or congestive heart failure in prior six months, and prior lung transplantation, LVRS, bullectomy or lobectomy were excluded from the study.
The Chartis System was used to confirm that all 190 patients had little to no collateral ventilation and would be likely responders to the Zephyr Valve treatment, and were evaluated initially at six months with follow-up for an additional six months.
One hundred ninety patients with hyperinflation were randomized two-to-one for Zephyr Valves plus medical management (Zephyr Valve Group) or medical management alone (which may include drug therapy, pulmonary rehabilitation and supplemental oxygen) (Control Group) (128 Zephyr Valves patients: 62 Control Group patients) and followed for 12 months. Patients in the Zephyr Valve Group had Zephyr Valves placed in the target lobe to achieve lobar occlusion. Both the Zephyr Valve Group and Control Group patients continued to receive optimal medical management according to current clinical practice. Following their 12-month evaluation, the Control Group patients had an option to receive Zephyr Valve treatment, of which 47 out of 59 (80%) elected to do so. The LIBERATE study had high patient retention with 94% of patients completing follow-up for evaluation for 12 months.
The primary effectiveness endpoint was the percentage of patients enrolled in the Zephyr Valve Group who met the threshold of ≥15% improved FEV1 as compared to the Control Group at 12 months.
The secondary effectiveness endpoints included standard validated assessments commonly used in COPD studies:
1)FEV1, a measure of lung function: Difference between the Zephyr Valve Group and the Control Group in absolute change from baseline for FEV1 at 12 months;
2)6MWD, a measure of exercise capacity: Difference between the Zephyr Valve Group and Control Group in absolute change from baseline for 6MWD at 12 months; and
3)St. George’s Respiratory Questionnaire (SGRQ), a measure of quality of life: Difference between the Zephyr Valve Group and Control Group in absolute change from baseline for SGRQ score at 12 months.
Other endpoints included additional measures of lung function, exercise capacity, breathlessness and quality of life. Adverse events and serious adverse events were evaluated for the Treatment Period (day of procedure to 45 days), and Long-Term Period (46 days after procedure to 12 months) to assess safety.
20
Results
Effectiveness
The study met its primary and secondary endpoints at 12 months.
In the Zephyr Valve Group, 47.7% of patients achieved an FEV1 improvement of ≥15% from baseline to 12 months compared to 16.8% of patients in the Control Group (p<0.001).
Figure shows the primary endpoint of FEV1 Responders (FEV1 improvement of ≥15%) at 12 months
The absolute change in FEV1 showed significantly greater mean improvement (improved forced expiratory volume) in the Zephyr Valve Group compared to the Control Group (Δ Zephyr Valve - Control = +0.106L, p<0.001); the 6MWD showed significantly greater mean improvement (increased distance walked) in the Zephyr Valve Group compared to the Control Group (Δ Zephyr Valve - Control = +39.31 meters, p=0.002), and the SGRQ showed significantly greater mean improvement (score reduction) in the Zephyr Valve Group compared to the Control Group (Δ Zephyr Valve - Control = −7.05, p=0.004).
 |  |  | ||||||
Figure above presents secondary endpoints as mean changes ± standard error of the mean (SEM) from baseline to 12 months for the Zephyr Valve and Control Groups
21
Target lobe volume reduction was successfully achieved with 84% of patients having volume reductions of 350 mL or greater, where 350 mL lobe volume reduction is considered to be the Minimal Clinically Important Difference (MCID). Across a broad range of effectiveness endpoints, patients in the Zephyr Valve Group showed a substantially higher rate of clinically meaningful benefits when compared to patients in the Control Group, with responder rates ranging from 42-62% for individual measures.
73% of patients in the Zephyr Valve Group had a clinically meaningful response to at least one of FEV1, 6MWD and SGRQ score. Responder rates based on the individual MCID for the various endpoints at 12 months are shown in the figure below.
Figure above shows Responder rates based on individual MCID for various endpoints at 12 months
22
Safety
The safety of the treatment with Zephyr Valves was assessed by comparing adverse event profiles of patients in the Zephyr Valve Group and Control Group occurring over two time periods: Treatment Period (day of procedure to 45 days) and the Longer-Term Period (46 days after procedure to 12 months). Serious adverse events included pneumothorax, COPD exacerbation, pneumonia, respiratory failure and death.
Proportion of Patients Experiencing Pulmonary Serious Adverse Events Occurring in at Least 3% of Patients in Zephyr Valve and Control Groups | |||||||||||||||||||||||||||||||||||
Treatment Period 0 to 45 days | Longer-Term Period 46 days to 12 months | ||||||||||||||||||||||||||||||||||
Zephyr Valve Group N=128 | Control Group N=62 | ∆ Zephyr Valve - Control | Zephyr Valve N=128 | Control N=62 | ∆ Zephyr Valve - Control | ||||||||||||||||||||||||||||||
| Death | 3.1% | 0% | 3.1% | 0.8% | 1.6% | -0.8% | |||||||||||||||||||||||||||||
| Pneumothorax | 26.6% | 0% | 26.6% | 6.6% | 0% | 6.6% | |||||||||||||||||||||||||||||
| COPD Exacerbation | 7.8% | 4.8% | 3.0% | 23.0% | 30.6% | -7.6% | |||||||||||||||||||||||||||||
| Pneumonia | 0.8% | 0% | 0.8% | 5.7% | 8.1% | -2.4% | |||||||||||||||||||||||||||||
| Respiratory Failure | 1.6% | 0% | 1.6% | 0.8% | 3.2% | -2.4% | |||||||||||||||||||||||||||||
There were a higher number of serious adverse events in the Zephyr Valve Group compared to the Control Group during the Treatment Period. The most common serious adverse events in the Zephyr Valve Group versus the Control Group during the Treatment Period were pneumothorax and COPD exacerbations.
The majority of pneumothoraces (76%) occurred within three days following a bronchoscopy procedure. Four deaths occurred in the Treatment Period in the Zephyr Valve Group and none in the Control Group. Three of the four deaths were deemed by the investigators to be definitely related to treatment with Zephyr Valves and the remaining one was deemed by the investigators to be probably related to treatment with Zephyr Valves. Each patient that died experienced pneumothorax, with three deaths directly attributed to the pneumothorax and the fourth death the result of respiratory failure after the pneumothorax had resolved. In order to more closely monitor patients, the study protocol was subsequently amended to keep patients in the hospital for five nights. Based on the full study data, current practice is to keep patients in hospital for a minimum of three nights post-treatment. Post-hoc analysis has helped us identify risk factors for the group of patients at higher risk of having a complex pneumothorax event (complex pneumothorax defined as requiring removal of all valves or resulting in death) should one occur. Such high-risk patients include those who are not treated in the most diseased lobe and have greater than 60% destruction of the untreated lung. All four patients who experienced a pneumothorax and died were within this high-risk group. Further, all four pneumothorax events occurred in subjects that were not treated in the most diseased lobe and had more than 60% emphysema destruction in the contralateral lung. This learning is incorporated in our physician training program for physicians to identify such high-risk patients and to consider alternative targets or other risk mitigation strategies. During the Longer-Term Period, there was one death (0.8%) in the Zephyr Valve Group from a COPD exacerbation, deemed by the investigators not to be related to treatment with Zephyr Valves, and one cardiac arrhythmia death in the Control Group (1.6%).
Patients who experienced a pneumothorax following treatment with Zephyr Valves and whose pneumothorax had been resolved, experienced meaningful clinical benefit once they recovered from the pneumothorax event, with benefits comparable to patients who did not experience such pneumothorax events.
In the Longer-Term Period, the Zephyr Valve Group showed a non-statistically meaningful trend towards a reduction in COPD exacerbations requiring hospitalization and statistically significant reductions in respiratory failure events.
23
There were a number of secondary bronchoscopy procedures (consistent with study protocol) either to adjust a valve or to manage adverse events. There were 11 adjustment procedures in 11 patients following verification of lobar occlusion from the HRCT-assessment at 45-days. There were 21 procedures purely for valve removal (related to an adverse event) in 17 patients, and ten valve replacement procedures in eight patients (valve replacement procedures could entail simultaneous removal and replacement, or replacement for a valve previously removed). Five patients experienced a pneumothorax event following a valve adjustment procedure. See also Part I, Item 1A, “Risk Factors—Risks Related to Our Business and Strategy—Use of the Zephyr Valve involves risks and may result in complications, including pneumothorax or death, and is contraindicated in certain patients, which may limit adoption and negatively affect our business, financial condition and results of operations.”
Additional Post Hoc Analysis of LIBERATE Data
In July 2020, Dransfield et al. published a post hoc analysis of patient reported outcomes (PRO) from the LIBERATE trial which found that patients with severe emphysema and hyperinflation who achieve lung volume reduction following treatment with Zephyr Valves experience moderate to large improvements in multidimensional scores for breathlessness, activity, and psychosocial parameters that may permit re-engagement in activities of daily living out to at least 12 months. Patients treated with the Zephyr Valves also reported experiencing significantly more days when their symptoms were “better” and fewer days that were “worse” over 12 months compared to the control group. The authors concluded that interruption of the downward spiral of symptom-induced inactivity, muscle deconditioning, and ensuing weakness allows patients to experience improved activity, feeling of well-being, more confidence, and a better quality of life.
Summary of the TRANSFORM Study
The TRANSFORM study was a company-sponsored, multicenter, prospective, randomized, controlled clinical trial of Zephyr Valve treatment in patients with heterogeneous severe emphysema and little to no collateral ventilation conducted at 17 study sites in Europe. The study was conducted between January 2014 and April 2017, and the results were published in September 2017 in the American Journal of Respiratory and Critical Care Medicine.
Key inclusion criteria were severe emphysema patients with heterogeneous disease (≥10 difference in destruction scores between the target and adjacent lobes), ex-smokers over 40 years of age, with post- BD FEV1 between 15% and 45% predicted, TLC greater than 100% predicted, RV equal to or greater than 180% predicted, and a 6MWD
24
between 100 and 450 meters and little to no collateral ventilation. Patients with two or more COPD exacerbations requiring hospitalization in the last year, known pulmonary hypertension, myocardial infarction or other cardiovascular events in prior six months, and prior lung transplantation, LVRS, bullectomy or lobectomy were excluded from the study. Eligible patients were randomly assigned at a 2:1 ratio into either the Zephyr Valve treatment plus medical management (Zephyr Valve Group) or medical management alone (which may include drug therapy, pulmonary rehabilitation and supplemental oxygen) (Control Group) (65 Zephyr Valve patients: 32 Control Group patients).
The Chartis System was used to confirm that all 97 patients had little to no collateral ventilation and would be likely responders to the Zephyr Valve treatment, and were evaluated initially at six months with follow-up for an additional six months.
Patients in both groups were observed at 45-day, three-month and six-month periods. Patients in the Control Group were required to complete a minimum six-month follow-up. Following their six-month evaluation, the Control Group patients had an option to receive Zephyr Valve treatment, if eligible, which is commercially available in Europe, or remain in the Control Group for an additional six months. Only two Control Group patients elected to continue for an additional six months and the other patients opted to seek Zephyr Valve treatment commercially.
The primary effectiveness endpoint was the percentage of patients in the Zephyr Valve Group meeting the MCID of ≥12% improved post- BD FEV1 at three months post-treatment compared to the percentage of patients in the Control Group.
Other endpoints included additional measures of lung function, exercise capacity, breathlessness, hyperinflation, health status and quality of life measures. Adverse events and serious adverse events were evaluated for the Treatment Period (day of procedure to 45 days) and Longer-Term Period (46 days from procedure day to six months).
Results
Effectiveness
The study met its primary and secondary endpoints at three months.
25
At three months, 55% of patients on an ITT basis and 67% of patients on a per protocol (PP) basis achieved a ≥12% change in FEV1 from baseline, compared to 6.5% for the ITT and 6.7% for the PP patients in the Control Group (p<0.001 for both). This was statistically superior to medical management alone.
Figure above shows the responder rate (primary endpoint) for the Intention-to-Treat and Per Protocol Populations at three months
The study met its secondary endpoints, with durable and statistically significant benefits in favor of the Zephyr Valve Group out to six months across multiple measures. Lung function assessed by FEV1 showed a 29% (p<0.001) improvement in the Zephyr Valve Group over the Control Group, exercise capacity assessed by 6MWD improved by 79 meters (p<0.001), quality of life assessed by the SGRQ score improved by 6.5 points (p=0.031), hyperinflation assessed by a decrease in residual volume improved by 670 mL (p=0.002), and health status assessed by the BODE Index improved by 1.75 points (p<0.001). Target lobe volume reduction was successfully achieved with 90% of patients having volume reductions of greater than MCID.
26
Figures above show the improvements over time for FEV1, 6MWD, SGRQ, RV, and BODE Index out to six months.
Safety
At six months, 47.7% patients in the Zephyr Valve Group compared to 9.4% patients in the Control Group (p<0.001) had a respiratory related serious adverse event, with most events occurring within 45 days of the procedure. In the Zephyr Valve Group, there were 13 pneumothorax events in 13 patients (20%) during the 45-day Treatment Period (p=0.004). None of the other respiratory serious adverse events were statistically different between groups during the same period. Over the longer term (46 days through six months), there was no difference in respiratory serious adverse events between groups. There was one death in the Zephyr Valve Group due to an in-hospital cardiac arrest as a complication of a pneumothorax and was deemed by the investigator to be related to treatment with Zephyr Valves. See also “Risk Factors—Risks Related to Our Business and Strategy—Use of the Zephyr Valve involves risks and may result in complications, including pneumothorax or death, and is contraindicated in certain patients, which may limit adoption and negatively affect our business, financial condition and results of operations.”
Summary of the IMPACT Study
The IMPACT Study was a company sponsored, multicenter, randomized, controlled clinical trial of Zephyr Valves in patients with severe homogeneous emphysema at eight investigational sites in Europe. The study was conducted between August 2014 and March 2017, and the results of the primary endpoint at three months were published in August 2016 in the American Journal of Respiratory and Critical Care Medicine.
27
Key inclusion criteria were emphysema patients with homogeneous disease (<15 difference in destruction scores between the target and adjacent lobes), ex-smokers over 40 years of age, with post- BD FEV1 between 15% and 45% predicted, TLC greater than 100% predicted, RV equal to or greater than 200% predicted, a 6MWD equal to or greater than 150 meters and little to no collateral ventilation. Patients with three or more COPD exacerbations requiring hospitalization in the last year, known pulmonary hypertension, myocardial infarction or other relevant cardiovascular events in prior six months, and prior LVR or LVRS, and greater than 20% difference in perfusion between the left and right lung were excluded from the study. Eligible patients were randomly assigned at a 1:1 ratio into either the Zephyr Valve procedure plus medical management (Zephyr Valve Group) or medical management alone (which may include drug therapy, pulmonary rehabilitation and supplemental oxygen) (Control Group) (43 Zephyr Valve patients: 50 Control Group patients).
The Chartis System was used to confirm that all 93 patients had little to no collateral ventilation and would be likely responders to the Zephyr Valve treatment, and were evaluated initially at six months with follow-up for an additional six months.
The primary effectiveness endpoint was the percentage change in FEV1 at three months relative to baseline in the Zephyr Valve Group, compared to the Control Group.
Other endpoints included additional measures of lung function, exercise capacity and quality of life measures. Adverse events and serious adverse events were evaluated for the Treatment Period (day of procedure to 30 days), and Long-Term Period (31 days after procedure to six months).
Results
Effectiveness
The study met its primary effectiveness endpoint. The mean percent change in FEV1 (L) from baseline to three months in the Zephyr Valve Group was an increase of 15.3% compared to a decrease of 3.4% in the Control Group. The mean group difference for the change in FEV1 from baseline to three months was 18.8 ± 22.1% (mean ± SD; p <0.001). Similar changes were observed in the ITT population. The mean percent change in FEV1 (L) from baseline to three months in the Zephyr Valve Group was an increase of 13.7% compared to a decrease of 3.2% in the Control Group. The mean group difference (Zephyr Valve - Control) for the change in FEV1 from baseline to three-months was 17.0 ± 21.4% (mean ± SD; p <0.001).
28
Figure above shows the percent change of FEV1 from baseline (primary endpoint) for the ITT groups at three months
The study also met its secondary outcomes. There were statistically significant and clinically meaningful improvements from baseline in the Zephyr Valve Group versus the Control Group at three months and six months with differences between the Zephyr Valve Group and Control Group for FEV1 (120 mL at 3 months and 120 mL at six months; p<0.001), RV (480 mL at three months and 430 mL at six months; p=0.011 and p=0.015, respectively), 6MWD (40 meters at three months and 28 meters at six months; p=0.002 and p=0.0156, respectively), SGRQ score (-9.6 at three months and -7.5 at six months; p<0.001), and Modified Medical Research Council (mMRC) Dyspnea Scale scores (-0.6 at three months and -0.4 at six months; p=0.01 and p=0.048, respectively). Target lobe volume reduction was successfully achieved with 89% of patients having volume reductions of greater than MCID.
 |  |  | ||||||
Figure above presents secondary endpoints as mean changes ± SEM from baseline to six months for the Zephyr Valve and Control Groups
Safety
There were a higher number of respiratory serious adverse events in the Zephyr Valve Group compared to the Control Group during the Treatment Period (day of procedure to 30 days; 44.2% patients versus 2.0% patients). The
29
most common respiratory serious adverse events in the Zephyr Valve Group versus the Control Group during the Treatment Period were pneumothorax in 23.3% versus 0.0%, respectively; and COPD exacerbations in 14.0% versus 2.0% patients, respectively. All pneumothoraces were managed using standard techniques that included chest tube placement and careful observation. There were a comparable number of serious respiratory adverse events in the Zephyr Valve Group compared to the Control Group during the Longer-Term Period (31 days to six months; 34.9% patients versus 26.0% patients, respectively).
The most common respiratory adverse events in the Zephyr Valve Group versus Control Group during the Longer-Term Period were COPD exacerbations in 18.6% versus 20.0% patients, respectively; dyspnea in 4.7% versus 0.0% patients, respectively; pneumothorax in 4.7% versus 0.0% patients, respectively; pneumonia in 2.3% versus 4.0% patients, respectively; and hypercapnia in 0.0% versus 6.0% patients, respectively. There were no deaths in the Zephyr Valve Group and two deaths in the Control Group that occurred in the Longer-Term Period. There was one death in the Zephyr Valve Group that occurred beyond 12-months after the Zephyr Valve implantation following severe COPD exacerbation after an abdominal surgery and was not related to treatment with Zephyr Valves. See also Part I, Item 1A, “Risk Factors—Risks Related to Our Business and Strategy—Use of the Zephyr Valve involves risks and may result in complications, including pneumothorax or death, and is contraindicated in certain patients, which may limit adoption and negatively affect our business, financial condition and results of operations.”
Summary of the STELVIO Study
The STELVIO study was an independent, non-company sponsored, randomized, controlled clinical trial conducted at a single center in the Netherlands that evaluated 68 patients with severe emphysema and hyperinflation. The study was conducted between June 2011 and November 2014, and the results of the primary endpoint were published in November 2015 in The New England Journal of Medicine.
Key inclusion criteria were severe emphysema patients with heterogeneous and homogeneous disease, ex-smokers over 35 years of age, with post- BD FEV1 less than 60% predicted, TLC greater than 100% predicted, RV greater than 150% predicted, dyspnea score of equal to or greater than two on the mMRC Dyspnea Scale, a 6MWD equal to or greater than 140 meters, and little to no collateral ventilation. Key exclusion criteria were prior LVRS, lung transplantation or lobectomy and evidence of other disease that may compromise survival or would interfere with completion of study. Eligible patients were randomly assigned at a 1:1 ratio to either Zephyr Valve treatment plus medical management (Zephyr Valve Group) or medical management alone (which may include drug therapy, pulmonary rehabilitation and supplemental oxygen) (Control Group) (34 Zephyr Valve patients: 34 Control Group patients).
The Chartis System was used to confirm that all 68 patients had little to no collateral ventilation and would be likely responders to the Zephyr Valve treatment, and were evaluated initially at six months with follow-up for an additional six months.
The primary outcome measures included differences between groups for changes in FEV1, Forced Vital Capacity (FVC) and 6MWD from baseline to six months.
Secondary outcome measures, among patients who completed the study, were improvements from baseline to six months in FEV1, FVC, 6MWD, SGRQ score and other health related measures.
Results
Effectiveness
The study met its primary and secondary effectiveness outcomes.
There were significantly greater improvements in the Zephyr Valve Group than in the Control group from baseline to six months with a between group increase in FEV1 of 140 mL (95% confidence interval (CI), 55 to 225), in FVC of 347 mL (95% CI, 107 to 588), in the 6MWD of 74 m (95% CI, 47 to 100) (p<0.01 for all comparisons). The data
30
are depicted in the figure and table below. Target lobe volume reduction was successfully achieved with 88% of patients having volume reductions of greater than MCID.
Figure above presents the co-primary endpoints as mean changes with 95% confidence intervals from baseline to six months for the Zephyr Valve and Control Groups
Effectiveness Outcomes for the Zephyr Valve and Control Groups at Six Months Values are Mean Change from Baseline for ITT Population | ||||||||||||||||||||
Zephyr Valve Group N=34 | Control Group N=34 | Difference Between Groups (Zephyr Valve - Control) | ||||||||||||||||||
FEV1 (%) | 20.9 | 3.1 | 17.8 | |||||||||||||||||
| FVC (%) | 18.3 | 4 | 14.4 | |||||||||||||||||
| 6MWD (%) | 19.6 | -3.6 | 23.3 | |||||||||||||||||
STELVIO was also the first randomized trial that evaluated outcomes in patients with homogeneous disease versus heterogeneous disease and showed that both groups benefited from treatment with Zephyr Valves. In general, the clinical outcomes after Zephyr Valve treatment were lower in the homogeneous patients compared to the heterogeneous patients but were still clinically meaningful (i.e., were greater than the MCID for each measure).
Effectiveness Outcomes for the Zephyr Valve Group who Completed the Study Values are Mean Change from Baseline | ||||||||||||||
Homogeneous Emphysema N=29 | Heterogeneous Emphysema N=22 | |||||||||||||
FEV1 (%) | 20.1 | 32.6 | ||||||||||||
| RV (%) | -16.3 | -16.6 | ||||||||||||
| 6MWD (meters) | 69 | 72 | ||||||||||||
| SGRQ score (points) | -13 | -19 | ||||||||||||
In subsequent follow-up of patients in the STELVIO study, these results were shown to be durable to at least one year. Furthermore, the BODE index at one year showed an improvement from baseline of -1.13 points (95% CI, -1.5 to -0.7; p <0.001); a reduction of more than one point in the BODE Index being associated with a decrease in mortality.
Safety
Over the six months, there were 23 serious adverse events in the Zephyr Valve Group, as compared with five in the Control group (p<0.001). Serious treatment related adverse events in the Zephyr Valve Group included pneumothorax (18% of patients) and events requiring valve replacement (12%) or removal (15%). There was one
31
death in the Zephyr Valve Group due to end-stage COPD with respiratory failure 58 days after treatment which was deemed by the investigator to be unrelated to treatment with Zephyr Valves.
There was one death during the six-month to 12-month period in the Zephyr Valve Group due to a myocardial infarction (313 days after treatment) unrelated to treatment with Zephyr Valves. In the Control Group, there were two deaths recorded at 160 and 267 days after the screening visit, both due to COPD progression. See also Part I, Item 1A, “Risk Factors—Risks Related to Our Business and Strategy—Use of the Zephyr Valve involves risks and may result in complications, including pneumothorax or death, and is contraindicated in certain patients, which may limit adoption and negatively affect our business, financial condition and results of operations.”
Other Clinical Trials
The VENT study was a multicenter randomized clinical trial conducted in the mid-2000s by Emphasys Medical evaluating the safety and effectiveness of the Zephyr Valve. The study enrolled 321 patients in the United States. While the study showed statistically significant improvement in FEV1 and 6MWD (co-primary endpoints), these were only clinically significant in a post hoc subset of patients that had complete fissures (a surrogate for absence of collateral ventilation) and lobar occlusion. The study did not meet its primary endpoints.
The BeLieVeR-HIFi study was a single center randomized, controlled, independent, non-company-sponsored study conducted in the early 2010s that enrolled 50 patients with complete fissures and severe heterogeneous emphysema. Patients were randomized to treatment with Zephyr Valves and medical management or a sham procedure and medical management. While Chartis assessment was performed to assess collateral ventilation prior to the procedure, inclusion in the study was based on visual assessment of complete fissures. The study showed clinical benefit in the Zephyr Valve treated patients although the outcomes were better in patients in whom collateral ventilation was ruled out using the Chartis System.
We are not aware of any prospective data regarding survival rates of patients who have undergone endobronchial valve treatment. There are two survival studies, however, that retrospectively evaluate patients treated with endobronchial valves. These studies compared survival rates between patients with significant volume reduction in the treated lobe (also called atelectasis) against those who did not have atelectasis. In one study, the patient population consisted of 449 patients with either heterogeneous or homogeneous emphysema five years following treatment with Zephyr Valves or other endobronchial valves. The majority of patients in this study were treated with Zephyr Valves. The results of this study suggested that patients with atelectasis were approximately 45% more likely to survive than patients without. Another study of 19 patients with only heterogeneous emphysema ten years following treatment with Zephyr Valves suggested that patients with atelectasis were approximately 166% more likely to survive than patients without atelectasis. We believe these studies are relevant because treatment with Zephyr Valves is intended to cause atelectasis in poorly functioning, hyperinflated lobes of the lung. In addition, the results of these studies add to the body of evidence showing the benefits of atelectasis in patients with severe
32
emphysema and hyperinflation, including the potential for increased survival rates when compared to valve treatment without atelectasis.
 |  | |||||||
Gompelmann et. al (2019): Survival after Endoscopic Valve Therapy in Patients with Severe Emphysema. Respiration; 97; 145-152. | Garner et al (2016): Survival after Endobronchial Valve Placement for Emphysema: A 10-Year Follow-up Study. Amer J Respir Crit Care Med.194 (4): 519-521. | |||||||
Reprinted with permission of S. Karger AG, Basel and Respiration. Copyright © 2020 S. Karger AG, Basel. Respiration is an official journal of the Swiss Respiratory Society and the European Association for Bronchology and Interventional Pulmonology. | Reprinted with permission of the American Thoracic Society. Copyright © 2020 American Thoracic Society. The American Journal of Respiratory and Critical Care Medicine is an official journal of the American Thoracic Society. | |||||||
Our Commercial Strategy
We have established a stepwise approach to market development which centers on active engagement across three key stakeholders in addressing severe emphysema: hospitals, physicians and patients.
We sell Zephyr Valves primarily through a direct sales force that engages with pulmonologists in the United States, Europe and Asia Pacific. Zephyr Valves are typically implanted by an interventional pulmonologist at a hospital, and patients are often evaluated in a multi-disciplinary team approach that includes other lung physicians, radiologists, respiratory therapy specialists or surgeons. Our sales personnel work closely with these stakeholders to ensure quality outcomes. We offer an in-depth training program developed in conjunction with leading global thought leaders and the largest pulmonary society in the United States. Our sales personnel work with hospitals to leverage their existing resources to efficiently establish and market Zephyr Valves as a service line. Our sales territory managers also call on community physicians and pulmonary rehabilitation centers to raise awareness of Zephyr Valves as a treatment option.
We seek to recruit sales territory managers with strong sales backgrounds, with direct experience developing markets with new technologies and an understanding of medical device reimbursement and the prior authorization process. In the United States, our territory managers are managed by region directors. We plan to expand our commercial organization, recruiting and training talented sales territory managers in existing and new markets in the United States to help facilitate further adoption and broaden awareness of Zephyr Valves. We believe investing in a scalable, efficient direct sales force and continuing the development of our marketing efforts will help us broaden adoption of our solution in order to drive revenue growth.
Our strategy is to identify territories with high unmet need, identify leading hospitals and work with champions of our solution to build emphysema centers of excellence. We believe there is a significant growth opportunity for hospitals to provide high quality comprehensive diagnosis and treatment for advanced COPD patients. We believe
33
we can efficiently serve the United States market, focusing on approximately 500 high volume hospitals, of which we currently cover a small fraction.
We intend to continue to promote awareness of our solution through training and educating physicians, pulmonary rehabilitation centers, key opinion leaders and various medical societies on the proven clinical benefits of Zephyr Valves. We continue to develop our relationships with credible third parties, such as our partnership with the American College of Chest Physicians, on continuing medical education-accredited training and with the COPD Foundation on patient and physician education. We also intend to continue helping physicians in their outreach to patients and other healthcare providers. In addition, we intend to continue to publish additional clinical data in various industry and scientific journals, online and through presentations at various industry conferences. We believe that many patients who suffer from severe emphysema are eager for a minimally invasive option such as the Zephyr Valve. We also plan to continue building patient awareness through our direct-to-patient marketing initiatives, which include advertising, social media and online education. We also intend to continue helping physicians in their outreach to patients and other healthcare providers.
The objective of this outreach is to bring patients to our website, where they can find educational materials on Zephyr Valves, determine if they may be eligible, find contact information for physicians in their area and sign up for support and news.
We conduct our international business through direct sales in markets with established reimbursement and substantial market potential, and through a distributor-based sales model in smaller markets or markets where we are still developing reimbursement.
Our strategy is to offer limited distribution and develop champions of our solution in high potential markets, and as reimbursement becomes available, change from a distributor-based sales model to a direct sales model. We have successfully followed this approach in most markets outside the United States in which we sell and we anticipate following a similar approach in the future.
Third-Party Reimbursement
There are three key components for reimbursement in the United States: (1) coding, (2) payment and (3) coverage. Our patient access team is responsible for all aspects of our reimbursement processes and initiatives. In the United States, our solution is reimbursed based on established Category I CPT and ICD-10 PCS codes and associated APC and MS-DRG payment groupings.
Coding
In the United States, we sell our products to hospitals. These customers in turn bill various third-party payors, such as commercial payors and government agencies, for the cost required to treat each patient.
Third-party payors require physicians and hospitals to identify the items and services for which they are seeking reimbursement by using standard codes for both physician and facility payments. “Coding” refers to distinct numeric and alphanumeric billing codes that are used by healthcare providers to report the provision of medical services procedures and the use of supplies for specific patients to payors. CPT codes are published by the American Medical Association and are used to report medical services and procedures performed by or under the direction of physicians. Medicare generally pays physicians for services based on submission of a claim using one or more specific CPT codes. Physician payment for procedures may vary according to site of service. Hospitals are reimbursed for inpatient procedures based on MS‐DRG classifications derived from patient demographic information and ICD-10-CM diagnosis and ICD-10 PCS codes that describe the patient’s diagnoses and procedures performed during the hospital stay.
34
Payment
Payment refers to the amount paid to providers for specific procedures and supplies. Physician reimbursement under Medicare generally is based on a defined fee schedule (Physician Fee Schedule) through which payment amounts are determined by the relative values of the service rendered. Medicare provides reimbursement to our hospital customers as a lump sum intended to cover all costs under a single MS-DRG payment. Reimbursement from commercial payors is typically based on a similar methodology but rates vary depending on the procedure performed, the hospital, the commercial payor, contract terms and other factors.
These ICD-10 PCS codes map to the MS-DRG classifications for Major Chest Procedures, with national average reimbursement rates between $12,000 and $32,000, for the year 2020, depending on co-morbidities and complications. MS‐DRG classifications calibrate payment for groups of services based on the severity of a patient’s illness and clinical cohesiveness of care. One single MS‐DRG payment is intended to cover all hospital costs associated with treating a patient during his or her hospital stay, while physician charges associated with performing medical procedures are reimbursed to physicians through a different payment system based on the codes they submit. Payment for Zephyr Valve is expected to, on average, be sufficient to cover costs of the procedure.
If a patient is positive for collateral ventilation following an assessment by the Chartis System, the patient is typically discharged the same day and the procedure therfore billed as an outpatient procedure. The CPT code used to provide payment for the Chartis procedure, for patients who do not receive the Zephyr Valve due to collateral ventilation, maps to an Ambulatory Payment Classification, with a national average payment of $5,823. If a patient receives the Zephyr Valve, there is no separate reimbursement for the Chartis System procedure; rather, the provider receives payment for the endobronchial valve procedures as described above.
The national Medicare average payment for physicians performing the endobronchial valve procedure is generally consistent with other complex bronchoscopic procedures.
Commercial Payor and Government Program Coverage
Coverage refers to decisions made by commercial third-party payors and government programs as to whether or not to provide their members access to and pay for specific procedures and related supplies, and if so, what conditions, such as specific diagnoses and clinical indications, are covered. Commercial payors typically base coverage decisions on reviews of clinical evidence presented in published peer-reviewed medical literature.
A majority of our patients are Medicare-eligible beneficiaries. Without a national coverage determination (NCD) or a local coverage determination (LCD), Medicare claims are processed by Medicare Administrative Contractors (MACs), which assess coverage under Medicare’s reasonable and necessary standard. We estimate that roughly 75% of the potential Zephyr Valve patient population are Medicare/Medicaid beneficiaries of which approximately 25% have managed Medicare/Medicaid and the remaining 50% have traditional fee-for-service Medicare/Medicaid. Approximately 25% of the potential Zephyr Valve patient population is under third-party commercial payor policies. A key element of our strategy remains to broaden our coverage by private third-party payor policies.
Commercial payors such as Aetna, Humana, Health Care Service Corporation, and Highmark have issued positive coverage policies for the Zephyr Valve, and United Healthcare no longer considers the procedure unproven or experimental. We continue to engage with commercial payors to establish positive national coverage policies by highlighting our compelling and robust clinical data, unique patient selection tools, favorable cost profile to more invasive options, increased patient demand and support from global treatment recommendations for the management of COPD and emphysema.
Prior Authorization Approval Process
A second key element of our reimbursement strategy includes leveraging our patient reimbursement support team and knowledge of the published data to assist patients and physicians in obtaining appropriate prior authorization approvals in advance of treatment for payers that require it. We believe our patient reimbursement support team is
35
highly effective in working with patients and physicians to obtain appropriate prior authorizations for the Zephyr Valve treatment even when a non-coverage policy exists. We believe patients and providers will continue to benefit from support through the prior authorization process until widespread coverage is established across most commercial payors.
Reimbursement Outside of the United States
Outside of the United States, reimbursement levels vary significantly by country and by patient. Reimbursement is obtained from a variety of sources, including government sponsors, hospital budgets or private health insurance plans, or combinations thereof. We have established reimbursement access in countries across Europe and Asia Pacific, including Australia, Belgium, France, Germany, the Netherlands, South Korea, the United Kingdom and other countries.
Research, Development and Clinical Programs
Our research and development team continues to design, develop and test new innovations to improve patient outcomes and expand our addressable market. We also work with external vendors in the design and testing of new technologies.
Since the early development of the Zephyr Valve, our company has produced a stream of innovations to increase the success rate of using the Zephyr Valve. This includes innovations in our airway sizing and delivery catheters, the introduction of new sizes of Zephyr Valves, improvements to the user interface of the Chartis System to accommodate a variety of anesthesia options and the StratX Platform to assist with patient selection and procedure planning.
We have had discussions with the FDA regarding expanding the Zephyr Valve indication to include the management of persistent air leaks. We believe there are approximately 7,000 patients who suffer from a persistent air leak per year in the United States that could benefit from treatment with Zephyr Valves.
Our pipeline of products that we are currently considering includes innovations in image analysis to support advanced patient selection and optimize patient outcomes, catheter technologies to improve valve deliverability and reduce procedure time and the AeriSeal system for addressing the needs of severe emphysema patients who are not eligible for Zephyr Valves due to collateral ventilation. In December 2020, AeriSeal received designation as a Breakthrough Device by the FDA. The breakthrough designation will provide prioritized and potentially accelerated review by the FDA, and provides eligibility for Medicare Coverage of Innovation Technology (MCIT), a rule which enables receipt of Medicare coverage as early as the same day as FDA market authorization for breakthrough devices and provides coverage for four years.
AeriSeal is a polymerizing sealant that can be delivered via a bronchoscope to a targeted region of the lung to reduce volume in the treated area. We intend to submit an IDE to the FDA for commencing a clinical trial with the AeriSeal system. We have only conducted initial feasibility research on AeriSeal to date. We believe that positive results from this clinical trial would enable the treatment of patients with collateral ventilation, which would complement the screening of patients for Zephyr Valves. We have secured CE mark and Therapeutic Goods Administration approval in Australia for AeriSeal and have completed initial feasibility research. We further have funded a feasibility study using AeriSeal to expand the number of patients that can be treated with Zephyr Valves and are exploring additional studies. If successfully developed and approved, AeriSeal could further expand the addressable market of our solution.
For the years ended December 31, 2020 and December 31, 2019, we incurred research and development expenses, including our clinical trials, of $7.5 million and $6.0 million, respectively.
36
Competition
Our industry is highly competitive and subject to rapid change from the introduction of new products and technologies and other activities of industry participants.
We are positioning our solution as an alternative to existing treatments of severe emphysema. These treatments include medical management, other minimally invasive treatments, LVRS and lung transplantations. The major competitive products include the Spiration Valve System (Olympus Corporation) and the InterVapor System (Broncus Medical, Inc.; not approved for use in the United States). The Spiration Valve System is an endobronchial technology designed to offer patients with severe emphysema a minimally invasive treatment option for lung volume reduction by redirecting air away from diseased areas of the lung to healthier tissue so that patients may breathe easier. Like Zephyr Valves, the Spiration Valve System is indicated to treat patients with heterogeneous emphysema; however, the Spiration Valve System is contraindicated for patients with homogeneous emphysema. We believe our solution competes favorably with the Spiration Valve System for several reasons, including the strength of our published clinical data, differentiated patient selection tools and our comprehensive technical and reimbursement support. InterVapor System offers a non-surgical and non-implant therapy developed for lung disease including emphysema and lung cancer where vapor ablation is simply the application of heated pure water to tissue.
Some of our current or future competitors may have several competitive advantages, including established relationships with pulmonologists who commonly treat patients with emphysema, significantly greater name recognition and significantly greater sales and marketing resources.
In addition to competing for market share, we also compete against these companies for personnel, including qualified sales and other personnel that are necessary to grow our business.
We believe the principal competitive factors in our market include the following:
•patient outcomes and adverse event rates;
•product safety, reliability and durability;
•patient experience;
•effective marketing to and education of patients, physicians and hospitals;
•acceptance by treating physicians and referral sources;
•physician learning curve;
•ease-of-use and reliability;
•patient recovery time and level of discomfort;
•economic benefits and cost savings;
•availability of coverage and adequate reimbursement; and
•strength of clinical evidence.
In addition to existing competitors, other companies may acquire or in-license competitive products and could directly compete with us. These competitors may also try to compete with us on price both directly, through rebates and promotional programs to high volume physicians and coupons to patients, and indirectly, through attractive product bundling with complementary products that offer convenience and an effectively lower price compared to
37
the total price of purchasing each product separately. Larger competitors may also be able to offer greater customer loyalty benefits to encourage repeat use of their products and finance a sustained global advertising campaign to compete with commercialization efforts of our products. Our competitors may seek to discredit our products by challenging our short operating history or relatively limited number of scientific studies and publications. Smaller companies could also launch new or enhanced products and services that we do not offer and that could gain market acceptance quickly. Additionally, certain of our competitors may challenge our intellectual property, may develop additional competing or superior technologies and processes and compete more aggressively and sustain that competition over a longer period of time than we could. Our technologies and products may be rendered obsolete or uneconomical by technological advances or entirely different approaches developed by one or more of our competitors. As more companies develop new intellectual property in our market, there is the possibility of a competitor acquiring patents or other rights that may limit our ability to update our technologies and products which may impact demand for our products.
Intellectual Property
We rely on a combination of patent, copyright, trademark and trade secret laws and confidentiality and invention assignment agreements to protect our intellectual property rights. As of December 31, 2020, we had 39 patent families in force worldwide. As of December 31, 2020, we had rights to 60 issued United States patents, 17 pending United States patent applications, 133 issued foreign patents and 13 pending foreign patent applications. Our most material foreign patents issued and patent applications pending are in the European Union, France, Germany, Japan and the United Kingdom. Our patents cover aspects of our current Zephyr Valve, loading system, airway sizing, EDC, Chartis System, AeriSeal and future product concepts. The term of individual patents depends on the legal term for patents in the countries in which they are granted. In most countries, including the United States, the patent term is generally 20 years from the earliest claimed filing date of a nonprovisional patent application in the applicable country. Our patents expire between 2021 and 2038. We have applied to the U.S. Patent and Trademark Office (USPTO) seeking an extension for the term of a material Zephyr Valve patent from 2023 to 2027 under the Patent Term Extension which allows additional term to be added to a patent to compensate for the FDA approval process. Once a patent expires, the protection ends, and an invention enters the public domain; that is, anyone can commercially exploit the invention without infringing the patent.
There is no active patent litigation involving any of our patents and we have not received any notices claiming that our activities infringe a third party’s patent.
We cannot guarantee that patents will be issued from any of our pending applications or that, if patents are issued, they will be of sufficient scope or strength to provide meaningful protection for our technology. Notwithstanding the scope of the patent protection available to us, a competitor could develop treatment methods or devices that are not covered by our patents. Furthermore, numerous United States and foreign-issued patents and patent applications owned by third parties exist in the fields in which we are developing products. Because patent applications can take many years to publish, there may be applications unknown to us, which may later result in issued patents that our existing or future products or technologies may be alleged to infringe.
There has been substantial litigation regarding patent and other intellectual property rights in the medical device industry. In the future, we may need to engage in litigation to enforce patents issued or licensed to us, to protect our trade secrets or know-how, to defend against claims of infringement of the rights of others or to determine the scope and validity of the proprietary rights of others. Litigation could be costly and could divert our attention from other functions and responsibilities. Furthermore, even if our patents are found to be valid and infringed, a court may refuse to grant injunctive relief against the infringer and instead grant us monetary damages or ongoing royalties. Such monetary compensation may be insufficient to adequately offset the damage to our business caused by the infringer’s competition in the market. Adverse determinations in litigation could subject us to significant liabilities to third parties, require us to seek licenses from third parties or could prevent us from manufacturing, selling or using the product accused of infringement, any of which could severely harm our business. See Part I, Item 1A, “Risk Factors—Risks Related to our Intellectual Property” for additional information regarding these and other risks related to our intellectual property portfolio and their potential effect on us.
38
We also rely upon trademarks to build and maintain the integrity of our brand. As of December 31, 2020, we had eight registered trademark filings, some of which may apply to multiple countries, and several pending trademark applications in various countries.
We also rely, in part, upon unpatented trade secrets, know-how and continuing technological innovation, and licensing arrangements, to develop and maintain our competitive position. We protect our proprietary rights through a variety of methods, including confidentiality and assignment agreements with suppliers, employees, consultants and others who may have access to our proprietary information.
Cross-Licensing Agreement with Spiration/Olympus
In January 2005, Emphasys Medical (Emphasys), a company we later acquired, entered into a cross-license agreement (Spiration Cross-License) with Spiration, Inc. (Spiration) (later acquired by Olympus Medical Systems Corp.). Since both companies were developing products in the same field, they entered into this agreement to minimize the risk of intellectual property disputes in the future and their associated cost. When we acquired Emphasys in 2009, we became the successor-in-interest to Emphasys’ rights under the Spiration Cross-License. Under the agreement, each company non-exclusively licensed the other party to make, have made (solely for such other party), sell, offer for sale, import and export specific products under their respective patent portfolio at that time that covers such products or a method of use thereof. The license granted to us by Spiration is limited to devices where the outer perimeter of the device seals with the airway wall and the device allows fluid flow only through one or more openings in the device radially inward of such outer perimeter. It does not give us a license under Spiration’s patent rights to valve devices that allow fluid flow only between the outer perimeter of the device and the airway wall. Similarly, the license granted to Spiration by us is limited to devices that allow fluid flow only between the outer perimeter of the device and the airway wall. It does not give Spiration a license under our patent rights to make or sell valve devices where the outer perimeter of the device seals with the airway wall and the device allows fluid flow only through one or more openings in the device radially inward of such outer perimeter. The licenses cannot be sublicensed. Furthermore, each license also includes a covenant not to sue the other party for infringement with respect to specified product elements, designs and features. The Spiration Cross-License can be terminated by either party upon 60 days’ written notice to the other in the event certain patents are no longer owned by the other party or such patents are no longer in force; provided, that, the parties are required to negotiate in good faith during such 60-day notice period to attempt to enter into a replacement cross-license prior to such termination. Neither party may assign or otherwise transfer the Spiration Cross-License without the written consent of the other party, except in connection with certain change-of-control transactions. We do not have any relationship with Spiration other than with respect to this cross-license agreement.
Manufacturing and Supply
We manufacture all our products — valves, delivery catheters, balloon catheters and the Chartis System console — at our headquarters located at 700 Chesapeake Drive, Redwood City, California 94063 where we lease approximately 25,000 square feet of space. Our lease terminates on July 31, 2025. This facility supports production and distribution operations, including manufacturing, quality control, raw material and finished goods storage. We have manufactured all our products at this facility for over 10 years and to date we have manufactured over 80,000 Zephyr Valves. We also store finished goods at other facilities in Redwood City, California where we lease approximately 8,000 square feet and 17,000 square feet of space under lease agreements that terminates on May 31, 2024 and September 30, 2024, respectively. There is a mutual early termination option starting November 30, 2021 on the 8,000 square feet of space.
We rely on a combination of in-house processing and third-party suppliers for raw materials and components. We have supply agreements with a few critical suppliers while procuring most of our materials on a purchase order basis. Suppliers are routinely evaluated based on industry standards including on-site audits, as required, to be approved. We have a strict change control policy with our suppliers to ensure that no design or process changes are made without our prior approval. Based on our prior experience with such suppliers to manufacture products for commercialization both inside and outside the United States, we believe these suppliers are capable of continuing to meet our specifications and maintaining quality. Several components used in our devices rely on single source
39
suppliers and we routinely prioritize, evaluate and qualify backup sources. We typically maintain several months of product in inventory however if one or more of our single source suppliers were to encounter a manufacturing issue or chooses to end supply, we estimate that some of our custom components could take between one and two years to qualify a second source supplier in all markets. The manufacture of AeriSeal, which is still in development, is completely outsourced to a contract manufacturer. The StratX Platform’s QCT service is currently outsourced as well. We host the customer-facing web portal for the StratX Platform’s QCT service while using a third-party cloud service provider to direct CT scan uploads from customers to qualified radiological image analysis providers.
We perform the final assembly, inspection, testing, packaging and product release testing for the Zephyr Valve, the EDC and Chartis System at our headquarters in Redwood City. These products are sterilized using ethylene oxide at a qualified sterilization supplier in Los Angeles, California. In the United States, we generally ship products from our third party logistics provider in Memphis, Tennessee and our facilities in Redwood City to our direct sales territory managers, who deliver these products to our hospital customers. Once they are trained and proficient in the procedure, we may also sell our products directly to our hospital customers. Internationally, we ship our products to a qualified third-party logistics provider in the Netherlands who, in turn, may either ship directly to our customers in Europe, Australia and other international markets on a consignment basis or directly to our sales territory managers in these countries who then sell these products to our customers. We also ship from our Redwood City facilities to distributors in Asia Pacific and other international markets.
Our manufacturing and distribution operations are subject to regulatory requirements of the FDA’s QSR for medical devices sold in the United States, set forth in 21 CFR part 820, and the EU’s Medical Device Directive (MDD) or Medical Device Regulation (MDR) for medical devices marketed in the European Union. We are also subject to applicable local regulations relating to the environment, waste management and health and safety matters, including measures relating to the release, use, storage, treatment, transportation, discharge, disposal, sale, labeling, collection, recycling, treatment and remediation of hazardous substances.
The FDA monitors compliance with the QSR through periodic inspections of our facilities, which may include inspection of our suppliers’ facilities as well. Our European Union Notified Body, British Standards Institute (BSI), monitors compliance with the MDD requirements through both annual scheduled audits and periodic unannounced audits of our manufacturing facilities as well as our contract third-party suppliers’ facilities.
Our failure, or the failure of our third-party suppliers, to maintain acceptable quality requirements could result in the shutdown of our manufacturing operations or the recall of our products. If one of our suppliers fails to maintain acceptable quality requirements, we may have to qualify a new supplier, which could adversely affect manufacturing of our products and result in manufacturing delays as well as have a material adverse effect on our business and financial condition.
Our quality management system in our Redwood City manufacturing facility is currently ISO 13485:2016 certified, MDD certified and licensed by the California Department of Public Health (CDPH) Food and Drug Branch. Our manufacturing facility is an FDA-registered medical device establishment. BSI will audit our facility to the MDR during 2021.
The FDA conducted a total of two establishment inspections of our manufacturing facility in 2014 and 2016. We believe that we are in compliance, in all material respects, with all applicable FDA and QSR requirements.
Manufacturing of the materials and components of our products are provided by approved suppliers, all of which are single source suppliers of key components, sub-assemblies and materials. The suppliers for the products are evaluated, qualified and approved through a stringent supplier management program, which includes various evaluations, assessments, qualifications, validations, testing and inspection to ensure the supplier can meet acceptable quality requirements. We implement a strict change control policy with our key suppliers to ensure that no component or process changes are made without our prior approval.
Order quantities and lead times for components purchased from suppliers are based on our forecasts derived from historical demand and anticipated future demand. Lead times for components may vary depending on the size of the
40
order, time required to manufacture and test the components, specific supplier requirements and current market demand for the components, sub-assemblies and materials. We perform assembly, testing, inspection and final product release activities for our products.
Government Regulation
United States Food and Drug Administration
Our products and operations are subject to extensive and ongoing regulation by the FDA under the Federal Food, Drug, and Cosmetic Act of 1938 and its implementing regulations (FDCA), as well as other federal and state regulatory bodies in the United States. The laws and regulations govern, among other things, product design and development, pre-clinical and clinical testing, manufacturing, packaging, labeling, storage, record keeping and reporting, clearance or approval, marketing, distribution, promotion, import and export and post-marketing surveillance.
Unless an exemption applies, each new or significantly modified medical device we seek to commercially distribute in the United States will require either a premarket notification to the FDA requesting permission for commercial distribution under Section 510(k) of the FDCA, also referred to as a 510(k) clearance, or approval from the FDA of a PMA application. Both the 510(k) clearance and PMA processes can be resource intensive, expensive and lengthy, and require payment of significant user fees, unless an exemption is available.
Device Classification
Under the FDCA, medical devices are classified into one of three classes—Class I, Class II or Class III—depending on the degree of risk associated with each medical device and the extent of control needed to provide reasonable assurances with respect to safety and effectiveness.
Class I includes devices with the lowest risk to the patient and are those for which safety and effectiveness can be reasonably assured by adherence to a set of FDA regulations, referred to as the General Controls for Medical Devices (General Controls), which require compliance with the applicable portions of the QSR, facility registration and product listing, reporting of adverse events and malfunctions, and as appropriate, truthful and non-misleading labeling and promotional materials. Some Class I devices, also called Class I reserved devices, also require premarket clearance by the FDA through the 510(k) premarket notification process described below. Most Class I products are exempt from the premarket notification requirements.
Class II devices are those that are subject to the General Controls, and special controls as deemed necessary by the FDA to ensure the safety and effectiveness of the device (Special Controls). These Special Controls can include performance standards, patient registries, FDA guidance documents and post-market surveillance. Most Class II devices are subject to premarket review and clearance by the FDA. Premarket review and clearance by the FDA for Class II devices is accomplished through the 510(k) premarket notification process.
Class III devices include devices deemed by the FDA to pose the greatest risk such as life-supporting or life-sustaining devices, or implantable devices, in addition to those deemed novel and not substantially equivalent following the 510(k) process. The safety and effectiveness of Class III devices cannot be reasonably assured solely by the General Controls and Special Controls described above. Therefore, these devices are subject to the PMA application process, which is generally more costly and time consuming than the 510(k) process. Through the PMA application process, the applicant must submit data and information demonstrating reasonable assurance of the safety and effectiveness of the device for its intended use to the FDA’s satisfaction. Accordingly, a PMA application typically includes, but is not limited to, extensive technical information regarding device design and development, pre-clinical and clinical trial data, manufacturing information, labeling and financial disclosure information for the clinical investigators in device studies. The PMA application must provide valid scientific evidence that demonstrates to the FDA’s satisfaction a reasonable assurance of the safety and effectiveness of the device for its intended use.
41
The Zephyr Valve is a Class III device that has received FDA PMA approval.
The Investigational Device Exemption Process
In the United States, absent certain limited exceptions, human clinical trials intended to support medical device clearance or approval require an IDE application. Some types of studies deemed to present “non-significant risk” are deemed to have an approved IDE once certain requirements are addressed and Institutional Review Board (IRB) approval is obtained. If the device presents a “significant risk” to human health, as defined by the FDA, the sponsor must submit an IDE application to the FDA and obtain IDE approval prior to commencing the human clinical trials. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of subjects. Generally, clinical trials for a significant risk device may begin once the IDE application is approved by the FDA and the study protocol and informed consent are approved by appropriate IRBs at the clinical trial sites. There can be no assurance that submission of an IDE application will result in the ability to commence clinical trials, and although the FDA’s approval of an IDE application allows clinical testing to go forward for a specified number of subjects, it does not bind the FDA to accept the results of the trial as sufficient to prove the product’s safety and effectiveness, even if the trial meets its intended success criteria.
All clinical trials must be conducted in accordance with the FDA’s IDE regulations that govern investigational device labeling, prohibition of promotion, recordkeeping, and reporting and monitoring responsibilities of study sponsors and study investigators. Clinical trials must further comply with the FDA’s good clinical practice regulations for IRB approval and for informed consent and other human subject protections. Required records and reports are subject to inspection by the FDA. The results of clinical testing may be unfavorable, or, even if the intended safety and effectiveness success criteria are achieved, may not be considered sufficient for the FDA to grant marketing approval or clearance of a product. The commencement or completion of any clinical trial may be delayed or halted, or be inadequate to support approval of a PMA application, for numerous reasons, including, but not limited to, the following:
•the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold;
•patients do not enroll in clinical trials at the rate expected;
•patients do not comply with trial protocols;
•patient follow-up is not at the rate expected;
•patients experience adverse events;
•patients die during a clinical trial, even though their death may not be related to the products that are part of the trial;
•device malfunctions occur with unexpected frequency or potential adverse consequences;
•side effects or device malfunctions of similar products already in the market that change the FDA’s view toward approval of new or similar PMAs or result in the imposition of new requirements or testing;
•IRBs and third-party clinical investigators may delay or reject the trial protocol;
•third-party clinical investigators decline to participate in a trial or do not perform a trial on the anticipated schedule or consistent with the clinical trial protocol, investigator agreement, investigational plan, good clinical practices, the IDE regulations, or other FDA or IRB requirements;
42
•third-party investigators are disqualified by the FDA;
•we or third-party organizations do not perform data collection, monitoring and analysis in a timely or accurate manner or consistent with the clinical trial protocol or investigational or statistical plans, or otherwise fail to comply with the IDE regulations governing responsibilities, records and reports of sponsors of clinical investigations;
•third-party clinical investigators have significant financial interests related to us or our study such that the FDA deems the study results unreliable, or we or third-party clinical investigators fail to disclose such interests;
•regulatory inspections of our clinical trials or manufacturing facilities, which may, among other things, require us to undertake corrective action or suspend or terminate our clinical trials;
•changes in government regulations or administrative actions;
•the interim or final results of the clinical trial are inconclusive or unfavorable as to safety or effectiveness; or
•the FDA concludes that our trial design is unreliable or inadequate to demonstrate safety and effectiveness.
The PMA Approval Process
Following receipt of a PMA application, the FDA conducts an administrative review to determine whether the application is sufficiently complete to permit a substantive review. If it is not, the agency will refuse to file the PMA. If it is, the FDA will accept the application for filing and begin the review. The FDA, by statute and by regulation, has 180 days to review a filed PMA application, although the review of an application more often occurs over a significantly longer period of time. During this review period, the FDA may request additional information or clarification of information already provided, and the FDA may issue a major deficiency letter to the applicant, requesting the applicant’s response to deficiencies communicated by the FDA. The FDA considers a PMA or PMA supplement to have been voluntarily withdrawn if an applicant fails to respond to an FDA request for information (for example, a major deficiency letter) within a total of 360 days. Before approving or denying a PMA, an FDA advisory committee may review the PMA at a public meeting and provide the FDA with the committee’s recommendation on whether the FDA should approve the submission, approve it with specific conditions, or not approve it. The FDA is not bound by the recommendations of an advisory committee, but it considers such recommendations carefully when making decisions.
Prior to approval of a PMA, the FDA may conduct inspections of the clinical trial data and clinical trial sites, as well as inspections of the manufacturing facility and processes. Overall, the FDA’s review of a PMA application generally takes between one and three years, but may take significantly longer. The FDA can delay, limit or deny approval of a PMA application for many reasons, including:
•the device may not be shown safe or effective to the FDA’s satisfaction;
•the data from pre-clinical studies or clinical trials may be found unreliable or insufficient to support approval;
•the manufacturing process or facilities may not meet applicable requirements; and
•changes in FDA approval policies or adoption of new regulations may require additional data.
If the FDA evaluation of a PMA is favorable, the FDA will issue either an approval letter, or an approvable letter, the latter of which usually contains a number of conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA
43
approval letter authorizing commercial marketing of the device, subject to the conditions of approval and the limitations established in the approval letter. If the FDA’s evaluation of a PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA or issue a not approvable letter. The FDA also may determine that additional tests or clinical trials are necessary, in which case the PMA approval may be delayed for several months or years while the trials are conducted and data is submitted in an amendment to the PMA, or the PMA is withdrawn and resubmitted when the data are available. The PMA process can be expensive, uncertain and lengthy and a number of devices for which the FDA approval has been sought by other companies have never been approved by the FDA for marketing.
New PMA applications or PMA supplements are required for modification to the manufacturing process, equipment or facility, quality control procedures, sterilization, packaging, expiration date, labeling, device specifications, ingredients, materials or design of a device that has been approved through the PMA process. PMA supplements often require submission of the same type of information as an initial PMA application, except that the supplement is limited to information needed to support any changes from the device covered by the approved PMA application and may or may not require as extensive technical or clinical data or the convening of an advisory panel, depending on the nature of the proposed change.
In approving a PMA application, as a condition of approval, the FDA may also require some form of post-approval study (PAS) or post-market surveillance, whereby the applicant conducts a follow-up study or follows certain patient groups for a number of years and makes periodic reports to the FDA on the clinical status of those patients when necessary to protect the public health or to provide additional or longer term safety and effectiveness data for the device. We are subject to certain PAS requirements under our PMA for the Zephyr Valve. PAS reports for the Zephyr Valve Registry study are required every six months for the first two years of the study and annually thereafter. PAS reports for the LIBERATE extension study are required annually. The FDA may also require post-market surveillance for certain devices cleared under a 510(k) notification, such as implants or life-supporting or life-sustaining devices used outside a device user facility. The FDA may also approve a PMA application with other post-approval conditions intended to ensure the safety and effectiveness of the device, such as, among other things, restrictions on labeling, promotion, sale, distribution and use.
Pervasive and Continuing Regulation
After a device is placed on the market, numerous regulatory requirements continue to apply. These include:
•the FDA’s QSR, which requires manufacturers, including their suppliers, to follow stringent design, testing, control, documentation and other quality assurance procedures during all aspects of the manufacturing process;
•labeling regulations and FDA prohibitions against the promotion of products for uncleared, unapproved or off-label uses;
•medical device reporting regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur;
•medical device recalls, which require that manufacturers report to the FDA any recall of a medical device, provided the recall was initiated to either reduce a risk to health posed by the device, or to remedy a violation of the FDCA caused by the device that may present a risk to health; and
•post-market surveillance regulations, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device.
We have registered with the FDA as a medical device manufacturer and have obtained a manufacturing license from the CDPH. The FDA and CDPH have broad post-market and regulatory enforcement powers. We are subject to unannounced inspections by the FDA and the Food and Drug Branch of CDPH to determine our compliance with
44
the QSR and other regulations, and these inspections may include the manufacturing facilities of our third-party suppliers. Additionally, our Notified Body, the BSI, regularly inspects our manufacturing, design and operational facilities to ensure ongoing ISO 13485 compliance in order to maintain our CE mark. Failure to comply with applicable regulatory requirements can result in enforcement action by the FDA or other regulatory bodies, which may include any of the following sanctions:
•warning letters, fines, injunctions, consent decrees and civil penalties;
•repair, replacement, refunds, recall or seizure of our products;
•operating restrictions, partial suspension or total shutdown of production;
•refusing our requests for 510(k) clearance or PMA approval of new products, new intended uses or modifications to existing products;
•withdrawing 510(k) clearance or PMA approvals that have already been granted; and
•criminal prosecution.
European Union
Our portfolio of products is regulated in the European Union as a medical device per the European Union Medical Devices Directive (Council Directive 93/42/EEC) (MDD) and, starting on May 26, 2021, the Medical Device Regulation (Regulation (EU) 2017/745) (MDR). The MDD and MDR set out the basic regulatory framework for medical devices in the European Union. The system of regulating medical devices operates by way of a certification for each medical device. Each certified device is marked with the CE mark which shows that the device has a Certificate de Conformité. There are national bodies known as Competent Authorities in each member state which oversee the implementation of the MDD or MDR within their jurisdiction. The means for achieving the requirements for the CE mark vary according to the nature of the device. Devices are classified in accordance with their perceived risks, similar to the United States system. The class of a product determines the conformity assessment required before the CE mark can be placed on a product. Conformity assessments for our products are carried out as required by the MDD or MDR. Each member state can appoint Notified Bodies within its jurisdiction. If a Notified Body of one member state has issued a Certificat de Conformité, the device can be sold throughout the European Union without further conformance tests being required in other member states. The CE mark is contingent upon continued compliance with the applicable regulations and the quality system requirements of the ISO 13485 standard. Our current CE mark is issued by BSI under the MDD. We will obtain a CE mark under the MDR prior to the expiration of the existing CE certificate.
Health Insurance Portability and Accountability Act
The Health Insurance Portability and Accountability Act of 1996 (HIPAA), as amended by the Health Information Technology for Economic and Clinical Health Act (HITECH), established federal protection for the privacy and security of health information. Under HIPAA, the United States Department of Health and Human Services (HHS), has issued regulations to protect the privacy and security of PHI used or disclosed by “Covered Entities,” including certain healthcare providers, health plans and healthcare clearinghouses, and their respective “Business Associates” that create, receive, maintain or transmit individually identifiable health information for or on behalf of a covered entity as well as their covered subcontractors, with respect to safeguarding the privacy, security and transmission of individually identifiable health information. HIPAA also regulates standardization of data content, codes and formats used in healthcare transactions and standardization of identifiers for health plans and certain healthcare providers. The HIPAA privacy regulations protect medical records and other PHI by limiting their use and release, giving patients the right to access their medical records and limiting most disclosures of health information to the minimum amount necessary to accomplish an intended purpose. The HIPAA security standards require the adoption of administrative, physical and technical safeguards and the adoption of written security policies and procedures. In addition, HIPAA requires Covered Entities to execute Business Associate Agreements with their Business
45
Associates and subcontractors who provide services for or on behalf of Covered Entities. Business Associates have a corresponding obligation to maintain appropriate Business Associate Agreements under HIPAA. In addition, companies that would not otherwise be subject to HIPAA may become contractually obligated to follow HIPAA requirements through agreements with Covered Entities and Business Associates, and some of our customers may require us to agree to these provisions.
In addition, various states, such as California and Massachusetts, have implemented similar privacy laws and regulations, such as the California Confidentiality of Medical Information Act, that impose restrictive requirements regulating the use and disclosure of health information and other personally identifiable information. In addition to fines and penalties imposed upon violators, some of these state laws also afford private rights of action to individuals who believe their personal information has been misused. California’s patient privacy laws, for example, provide for penalties of up to $250,000 and permit injured parties to sue for damages. The interplay of federal and state laws may be subject to varying interpretations by courts and government agencies, creating complex compliance issues and potentially exposing us to additional expense, adverse publicity and liability. The compliance requirements of these laws, including additional breach reporting requirements, and the penalties for violation vary widely, and new privacy and security laws in this area are evolving. Requirements of these laws and penalties for violations vary widely.
If we or our operations are found to be in violation of HIPAA, HITECH or their implementing regulations, and similar state laws, we may be subject to significant penalties, including civil, criminal and administrative penalties, fines, imprisonment and exclusion from participation in federal or state healthcare programs, and the curtailment or restructuring of our operations. In addition, HITECH created four new tiers of civil monetary penalties, amended HIPAA to make civil and criminal penalties directly applicable to Business Associates, and gave state attorneys general new authority to file civil actions for damages or injunctions in federal courts to enforce the federal HIPAA laws and seek attorney’s fees and costs associated with pursuing federal civil actions.
U.S. Federal, State and Foreign Fraud and Abuse Laws
The federal and state governments have enacted, and actively enforce, a number of laws to address fraud and abuse in federal healthcare programs. Our business is subject to compliance with these laws.
Anti-Kickback Statutes
The federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program, such as Medicare or Medicaid. A person or entity does not need to have actual knowledge of the statute or specific intent to violate it to have committed a violation.
The definition of “remuneration” has been broadly interpreted to include anything of value, including, for example, gifts, certain discounts, the furnishing of free supplies, equipment or services, credit arrangements, payment of cash and waivers of payments. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered businesses, the statute has been violated. Violations of the federal Anti-Kickback Statute may result in civil monetary penalties up to $100,000 for each violation, plus up to three times the remuneration involved. Violations can also result in criminal penalties, including criminal fines of up to $100,000 and imprisonment of up to ten years. Similarly, violations can result in exclusion from participation in government healthcare programs, including Medicare and Medicaid. Additionally, the intent standard under the federal Anti-Kickback Statute was amended by the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (Affordable Care Act) to a stricter standard such that a person or entity does not need to have actual knowledge of the statute or specific intent to violate it in order to have committed a violation. Further, the Affordable Care Act codified case law that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the civil False Claims Act (FCA).
46
There are a number of statutory exceptions and regulatory “safe harbors” protecting some common activities from prosecution, but the exceptions and safe harbors are drawn narrowly and require strict compliance to offer protection. The failure of a transaction or arrangement to fit precisely within one or more safe harbors does not necessarily mean that it is illegal or that prosecution will be pursued. However, conduct and business arrangements that do not fully satisfy an applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the HHS Office of the Inspector General (OIG).
Many states have adopted laws similar to the federal Anti-Kickback Statute. Some of these state prohibitions apply to referral of recipients for healthcare products or services reimbursed by any source, not only government healthcare programs, and may apply to payments made directly by the patient.
Government officials have focused their enforcement efforts on the marketing of healthcare services and products, among other activities, and recently have brought cases against companies, and certain individual sales, marketing and executive personnel, for allegedly offering unlawful inducements to potential or existing customers in an attempt to procure their business.
Federal False Claims Laws
The federal false claims laws, including the FCA, imposes liability on any person or entity that, among other things, knowingly presents, or causes to be presented, a false or fraudulent claim for payment by a federal healthcare program. The qui tam provisions of the FCA allow a private individual to bring actions on behalf of the federal government alleging that the defendant has violated the FCA and to share in any monetary recovery. In addition, various states have enacted false claims laws analogous to the FCA, and many of these state laws apply where a claim is submitted to any third-party payor and not only a federal healthcare program.
When an entity is determined to have violated the FCA, it may be required to pay up to three times the actual damages sustained by the government, plus significant civil fines and penalties. As part of a settlement, the government may require the entity to enter into a corporate integrity agreement, which imposes certain compliance, certification and reporting obligations. There are many potential bases for liability under the FCA. Liability arises, primarily, when an entity knowingly submits, or causes another to submit, a false claim for reimbursement to the federal government. The federal government has used the FCA to assert liability on the basis of kickbacks, or in instances in which manufacturers have provided billing or coding advice to providers that the government considered to be inaccurate. In these cases, the manufacturer faces liability for “causing” a false claim. In addition, the federal government has prosecuted companies under the FCA in connection with off-label promotion of products. Our activities, including those relating to the reporting of discount and rebate information and other information affecting federal, state and third-party reimbursement of our products (such as our patient reimbursement support programs) and the sale and marketing of our products, may be subject to scrutiny under these laws.
While we are unaware of any current matters, we are unable to predict whether we will be subject to actions under the FCA or a similar state law, or the impact of such actions. However, the costs of defending such claims, as well as any sanctions imposed, could significantly affect our financial performance.
Civil Monetary Penalties
The Civil Monetary Penalty Act of 1981 imposes penalties against any person or entity that, among other things, is determined to have presented or caused to be presented a claim to a federal healthcare program that the person knows or should know is for an item or service that was not provided as claimed or is false or fraudulent, or offering or transferring remuneration to a federal healthcare beneficiary that a person knows or should know is likely to influence the beneficiary’s decision to order or receive items or services reimbursable by the government from a particular provider or supplier.
47
Open Payments
The Physician Payments Sunshine Act (Open Payments), enacted as part of the Affordable Care Act, requires certain pharmaceutical, medical device and medical supply manufacturers covered by Medicare, Medicaid or the Children’s Health Insurance Program to report annually to CMS: payments and transfers of value to physicians (defined to include doctors, dentists, optometrists, podiatrists, and chiropractors) and teaching hospitals, and applicable manufacturers and group purchasing organizations, as well as to report annually ownership and investment interests held by physicians and their immediate family members. Failure to submit required information may result in civil monetary penalties of $11,052 per failure up to an aggregate of $165,786 per year (or up to an aggregate of $1.105 million per year for “knowing failures”), for all payments, transfers of value or ownership or investment interests that are not timely, accurately and completely reported in an annual submission, and may result in liability under other federal laws or regulations. Effective January 1, 2022, these reporting obligations will extend to include payments and other transfers of value made in the previous year to physician assistants, nurse practitioners, clinical nurse specialists, anesthesiologist assistants, certified registered nurse anesthetists and certified nurse midwives. We are subject to Open Payments and the information we disclose may lead to greater scrutiny, which may result in modifications to established practices and additional costs. Additionally, similar reporting requirements have also been enacted on the state level domestically, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring transparency of interactions with healthcare professionals.
Foreign Corrupt Practices Act
The Foreign Corrupt Practices Act (FCPA) prohibits any United States individual or business from paying, offering or authorizing payment or offering of anything of value, directly or indirectly, to any foreign official, political party or candidate for the purpose of influencing any act or decision of the foreign entity in order to assist the individual or business in obtaining or retaining business. The FCPA also obligates companies whose securities are listed in the United States to comply with accounting provisions requiring us to maintain books and records that accurately and fairly reflect all transactions of the corporation, including international subsidiaries, if any, and to devise and maintain an adequate system of internal accounting controls for international operations.
International Laws
In Europe, various countries have adopted anti-bribery laws providing for severe consequences in the form of criminal penalties and significant fines for individuals or companies committing a bribery offense. Violations of these anti-bribery laws, or allegations of such violations, could have a negative impact on our business, results of operations and reputation.
For instance, in the United Kingdom, under the U.K. Bribery Act of 2010 (Bribery Act), a bribery occurs when a person offers, gives or promises to give a financial or other advantage to induce or reward another individual to improperly perform certain functions or activities, including any function of a public nature. Bribery of foreign public officials also falls within the scope of the Bribery Act. An individual found in violation of the U.K. Bribery Act of 2010, faces imprisonment of up to ten years. In addition, the individual can be subject to an unlimited fine, as can commercial organizations for failure to prevent bribery.
There are also international privacy laws that impose restrictions on the access, use and disclosure of health information. All of these laws may impact our business. Our failure to comply with these privacy laws or significant changes in the laws restricting our ability to obtain required patient information could significantly impact our business and our future business plans.
United States Centers for Medicare and Medicaid Services
Medicare is a federal program administered by CMS through Medicare Administrative Contractors. Available to individuals age 65 or over, and certain other individuals, the Medicare program provides, among other things, healthcare benefits that cover, within prescribed limits, the major costs of most medically necessary care for such individuals, subject to certain deductibles and copayments.
48
CMS has established guidelines for the coverage and reimbursement of certain products and procedures by Medicare. In general, in order to be reimbursed by Medicare, a healthcare procedure furnished to a Medicare beneficiary must be reasonable and necessary for the diagnosis or treatment of an illness or injury, or to improve the functioning of a malformed body part. The methodology for determining coverage status and the amount of Medicare reimbursement varies based upon, among other factors, the setting in which a Medicare beneficiary received healthcare products and services. Any changes in federal legislation, regulations and policy affecting CMS coverage and reimbursement relative to the procedure using our products could have a material effect on our performance. While no NCD or LCD exists for endobronchial valves currently, CMS could develop an NCD, or one or more Medicare contractors could develop an LCD that either restricts coverage or restricts the patient population deemed appropriate for the treatment.
CMS also administers the Medicaid program, a cooperative federal/state program that provides medical assistance benefits to qualifying low income and medically needy persons. State participation in Medicaid is optional, and each state is given discretion in developing and administering its own Medicaid program, subject to certain federal requirements pertaining to payment levels, eligibility criteria and minimum categories of services. The coverage, method and level of reimbursement vary from state to state and is subject to each state’s budget restraints. Changes to the availability of coverage, method or level of reimbursement for relevant procedures may affect future revenue negatively if reimbursement amounts are decreased or discontinued.
All CMS programs are subject to statutory and regulatory changes, retroactive and prospective rate adjustments, administrative rulings, interpretations of policy, intermediary determinations, and government funding restrictions, all of which may materially increase or decrease the rate of program payments to healthcare facilities and other healthcare providers, including those paid for Zephyr Valve treatments.
United States Health Reform
Changes in healthcare policy could increase our costs and subject us to additional regulatory requirements that may interrupt commercialization of our current and future products. Changes in healthcare policy could increase our costs, decrease our revenue and impact sales of and reimbursement for our current and future products. The Affordable Care Act substantially changed the way healthcare is financed by both governmental and private insurers, and significantly impacts our industry. The United States and some foreign jurisdictions are considering or have enacted a number of legislative and regulatory proposals to change the healthcare system in ways that could affect our ability to sell our products profitably. Among policy makers and payors in the United States and elsewhere, there is significant interest in promoting changes in healthcare systems with the stated goals of containing healthcare costs, improving quality or expanding access. Current and future legislative proposals to further reform healthcare or reduce healthcare costs may limit coverage of or lower reimbursement for the procedures associated with the use of our products. The cost containment measures that payors and providers are instituting and the effect of any healthcare reform initiative implemented in the future could impact our revenue from the sale of our products.
The implementation of the Affordable Care Act in the United States, for example, has changed healthcare financing and delivery by both governmental and private insurers substantially, and affected medical device manufacturers significantly. The Affordable Care Act also provided incentives to programs that increase the federal government’s comparative effectiveness research, and implemented payment system reforms including a national pilot program on payment bundling to encourage hospitals, physicians and other providers to improve the coordination, quality and efficiency of certain healthcare services through bundled payment models. Additionally, the Affordable Care Act has expanded eligibility criteria for Medicaid programs and created a new Patient‑Centered Outcomes Research Institute to oversee, identify priorities in, and conduct comparative clinical effectiveness research, along with funding for such research. There have been executive, judicial and Congressional challenges to certain aspects of the Affordable Care Act. For example President Trump signed several Executive Orders and other directives designed to delay the implementation of certain provisions of the Affordable Care Act. Concurrently, Congress considered legislation to repeal or repeal and replace all or part of the Affordable Care Act. While Congress has not passed comprehensive repeal legislation, it has enacted laws that modify certain provisions of the Affordable Care Act such as removing penalties, starting January 1, 2019, for not complying with the Affordable Care Act’s individual mandate to carry health insurance and delaying the implementation of certain fees mandated by the Affordable Care
49
Act. On December 14, 2018, a Texas U.S. District Court Judge ruled that the Affordable Care Act is unconstitutional in its entirety because the individual mandate was repealed by Congress as part of the Tax Cuts and Jobs Act of 2017. Additionally, on December 18, 2019, the U.S. Court of Appeals for the 5th Circuit upheld the District Court ruling that the individual mandate was unconstitutional and remanded the case back to the District Court to determine whether the remaining provisions of the Affordable Care Act are invalid as well. The United States Supreme Court is currently reviewing this case, but it is unknown when a decision will be reached. Although the Supreme Court has not yet ruled on the constitutionality of the Affordable Care Act, on January 28, 2021, President Biden issued an executive order to initiate a special enrollment period from February 15, 2021 through May 15, 2021 for purposes of obtaining health insurance coverage through the Affordable Care Act marketplace. The executive order also instructs certain governmental agencies to review and reconsider their existing policies and rules that limit access to healthcare, including among others, reexamining Medicaid demonstration projects and waiver programs that include work requirements, and policies that create unnecessary barriers to obtaining access to health insurance coverage through Medicaid or the Affordable Care Act. It is unclear how the Supreme Court ruling, other such litigation and the healthcare reform measures of the Biden administration will impact the Affordable Care Act and our business.
In addition, other legislative changes have been proposed and adopted since the Affordable Care Act was enacted. For example, the Budget Control Act of 2011, among other things, included reductions to CMS payments to providers of 2% per fiscal year, which went into effect on April 1, 2013 and, due to subsequent legislative amendments to the statute, will remain in effect through 2030 unless additional Congressional action is taken. However, COVID-19 relief legislation suspended the 2% Medicare sequester from May 1, 2020 through March 31, 2021. Additionally, the American Taxpayer Relief Act of 2012, among other things, reduced CMS payments to several providers, including hospitals, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.
We believe that there will continue to be proposals by legislators at both the federal and state levels, regulators and third-party payors to reduce costs while expanding individual healthcare benefits. Certain of these changes could impose additional limitations on the rates we will be able to charge for our current and future products or the amounts of reimbursement available for our current and future products from governmental agencies or third-party payors. Current and future healthcare reform legislation and policies could have a material adverse effect on our business and financial condition. Further, it is possible that additional governmental action is taken in response to the COVID-19 pandemic.
Human Capital Management
Employees
As of December 31, 2020, we had 170 employees in the U.S., 38 in Europe, and 12 in Asia Pacific. None of our employees are represented by a labor union or are a party to a collective bargaining agreement. We believe that we have good relations with our employees.
Code of Business Conduct and Business Ethics
Pulmonx is dedicated to conducting its business consistent with the highest standard of business ethics. Each employee receives and agrees to follow the Pulmonx Code of Business Conduct and Ethics. Employees are encouraged to discuss any related concerns with management or report concerns anonymously through an Ethics Hotline.
Culture of Diversity, Equity, and Inclusion
At Pulmonx, we value diverse perspectives and experiences. We strive to create an inclusive culture where differences drive innovation. In 2020, we created a task force that seeks to ensure we make meaningful progress in advancing our commitment to being an inclusive organization where employees feel valued, respected, and heard.
50
Talent Management & Development
We believe that our employees are the foundation of our business and we are committed to the development and retention of our workforce. Our goal at Pulmonx is to become a “Talent Destination.”
Compensation Philosophy
To ensure we are able to attract, retain and develop high performing teams, we engage external compensation advisors to guide our efforts in developing cash and equity rewards programs that are competitive with our peer companies.
Total rewards
We offer competitive health and welfare programs to support our employees and their families’ physical, mental, and financial well-being. Our program offerings include the following:
•Medical, dental and vision insurance
•Retirement plan
•Flexible Spending Accounts for medical expenses, childcare, parking and transit
•Life insurance
•Short & long-term disability
•Paid time off
•Employee assistance program
In an effort to further align the interests of our employees with our shareholders, employees in most countries in which we operate have the opportunity to have an ownership interest in our company. We have an equity-based incentive plan that provides for the grant of stock options and awards to eligible employees. Additionally, we implemented an Employee Stock Purchase Plan that enables eligible employees to purchase our common stock at a discount through payroll contributions.
COVID-19 Health and Safety
The health and safety of our employees is a key focus at our Company. In response to the COVID-19 pandemic, the Company established safety protocols, facility enhancements, and work from home strategies to protect our employees. Some of our employees continue to work remotely. Employees that work on site are provided with personal protective equipment and are required to adhere to protocols for wearing masks at all times, social distancing, and reporting and documenting exposures, all following guidelines issued by the Centers for Disease Control or mandated by local regulations.
Available Information
Our website address is www.pulmonx.com. Information found on, or accessible through, our website is not a part of, and is not incorporated into, this Annual Report on Form 10-K. We file electronically with the U.S. Securities and Exchange Commission, or SEC, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, and amendments to those reports filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. We make available on our website at www.pulmonx.com, free of
51
charge, copies of these reports and other information as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. All SEC filings are also available at the SEC’s website at www.sec.gov
52
ITEM 1A. RISK FACTORS
Our business involves significant risks, some of which are described below. You should carefully consider these risks, as well as the other information in this Annual Report on Form 10-K, including our audited consolidated financial statements and the related notes and Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations.” The occurrence of any of the events or developments described below could have a material adverse effect on our business, results of operations, financial condition, prospects and stock price. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our business operations.
Risks Related to Our Business and Strategy
We have a history of significant net losses, which we expect to continue, and we may not be able to achieve or sustain profitability in the future.
We have incurred net losses since our inception. For the years ended December 31, 2020 and 2019, we had net losses of $32.2 million and $20.7 million, respectively, and we expect to continue to incur additional losses. As of December 31, 2020, we had an accumulated deficit of $242.7 million. We expect to continue to incur significant sales and marketing, research and development, regulatory and other expenses as we grow our sales force and expand our marketing efforts to increase adoption of our products, expand existing relationships with our customers, obtain regulatory clearances or approvals for our planned or future products, conduct clinical trials on our existing and planned or future products and develop new products or add new features to our existing products. The net losses that we incur may fluctuate significantly from period to period. We will need to generate significant additional revenue in order to achieve and sustain profitability. Even if we achieve profitability, we cannot be sure that we will remain profitable for any substantial period of time.
We have limited experience marketing and selling our solution.
We began commercializing our solution and the Zephyr Valve in the United States in 2018 and, through our predecessors, in Europe in 2003. Our limited commercialization experience and limited number of approved or cleared products make it difficult to evaluate our current business and predict our future prospects. These factors also make it difficult for us to forecast our future financial performance and growth, and such forecasts are subject to a number of uncertainties, including our ability to successfully complete clinical trials and obtain pre-market approval or 510(k) clearance by the FDA for future planned products in the United States or in key international markets. Our commercialization efforts will depend on the efforts of our management and sales team, our third-party suppliers, physicians and hospitals, and general economic conditions, among other factors, including the following:
•the effectiveness of our marketing and sales efforts in the United States and internationally;
•our success in educating physicians and patients about the benefits, administration and use of the Zephyr Valves;
•the acceptance by physicians, patients and payors of the safety and effectiveness of the Zephyr Valves, including the long-term data;
•our third-party suppliers’ ability to supply the components of the Zephyr Valves in a timely manner, in accordance with our specifications and in compliance with applicable regulatory requirements, and to remain in good standing with regulatory agencies;
•the impact of the COVID-19 pandemic on our business;
•the availability, perceived advantages, relative cost, relative safety and relative efficacy of alternative and competing therapies;
53
•our ability to obtain, maintain and enforce our intellectual property rights in and to the Zephyr Valves;
•the emergence of competing technologies and other adverse market developments, and our need to enhance the Zephyr Valves or develop new products to maintain market share in response to such competing technologies or market developments;
•our ability to raise additional capital on acceptable terms, or at all, if needed to support the commercialization of the Zephyr Valves; and
•our ability to achieve and maintain compliance with all regulatory requirements applicable to the Zephyr Valves.
If our assumptions regarding the risks and uncertainties we face, which we use to plan our business, are incorrect or change due to circumstances in our business or our markets, or if we do not address these risks successfully, it will negatively affect our business, financial condition and results of operations.
We currently rely on a single product, the Zephyr Valve, which can only be marketed for limited indications, and if we are not successful in commercializing the Zephyr Valve, our business, financial condition and results of operations will be negatively affected.
Our business currently depends entirely on our ability to successfully commercialize the Zephyr Valve, as well as our overall solution, in a timely manner. We have no other therapeutic products currently approved for sale in the United States and we may never be able to develop additional marketable products or enhancements to the Zephyr Valve solution. Currently, our solution is only available to treat patients with severe emphysema in the United States and additional limited indications internationally where we have obtained the necessary regulatory approvals or clearances. Therefore, we are dependent on widespread market adoption of our solution for this limited use-case and we will continue to be dependent on this use-case for the foreseeable future. There can be no assurance that our solution will gain a substantial degree of market acceptance among specialty physicians, patients or healthcare providers. Our failure to successfully increase sales of our solution or develop solutions that address forms of COPD beyond severe emphysema and obtain any necessary regulatory approvals or clearances in connection therewith could negatively affect our business, financial condition and results of operations.
Our success depends in large part on the success of the Zephyr Valve. If we are unable to successfully market and sell the Zephyr Valves, as well as our overall solution, to patients with severe emphysema, it will negatively affect our business, financial condition and results of operations.
Our success will depend on our ability to bring awareness to our solution, and the Zephyr Valve in particular, and educate hospitals and physicians regarding the benefits of our solution over existing products and services and to encourage those parties to recommend our solution to their patients. Sales of Zephyr Valves and delivery catheters accounted for most of our revenue for the years ended December 31, 2020 and 2019 and we expect that sales of Zephyr Valves and delivery catheters will continue to account for most of our revenue going forward. We do not know if our solution will be successful over the long term. Moreover, market acceptance may be hindered if physicians are not presented with compelling data demonstrating the efficacy of our solution compared to alternative procedures and technologies. Any studies we, or third parties which we sponsor, may conduct comparing our solution with alternative treatments for severe emphysema will be expensive, time consuming and may not yield positive results. Additionally, adoption will be directly influenced by a number of financial factors, including the ability of providers to obtain sufficient reimbursement from payors for deploying our solution. The safety, efficacy, performance and cost-effectiveness of our solution, on a stand-alone basis and relative to competing treatments and services, will determine the willingness of payors to cover the procedure. While we have established positive coverage policies with major national private payors, such as Aetna, Humana, Health Care Service Corporation, and Highmark, other commercial payors, including other plans in the Blue Cross Blue Shield family of plans, do not currently consider our solution medically necessary. No matter the level of coverage by the commercial payor, each patient is generally considered on a case-by-case basis. In addition, Medicare, currently without a public coverage policy, covers our solution for patients when medically necessary on a case-by-case basis. Physicians may be
54
reluctant to recommend our solution to patients covered by such plans with no specific policies because of the uncertainty surrounding reimbursement, rates and the administrative burden of interfacing with patients to answer their questions and support their efforts to obtain adequate reimbursement for our solution. If physicians do not adopt and recommend our solution, it will negatively affect our business, financial condition and results of operations.
Our business is dependent on hospital, physician and patient adoption of our solution as a treatment for severe emphysema. If hospitals, physicians or patients are unwilling to change current practices to adopt our solution, it will negatively affect our business, financial condition and results of operations.
Our primary strategy to grow our revenue is to take a stepwise approach to market development across key stakeholders in severe emphysema treatment, such as hospitals, physicians and patients. To succeed, our sales force must build deep relationships with pulmonary physicians to encourage them and their hospitals to develop emphysema centers of excellence, where physicians are instructed in the workup of advanced COPD and performance of bronchoscopic lung volume reduction using our solution, that offer our solution as a treatment for severe emphysema. In addition, we utilize direct-to-patient marketing initiatives to increase demand through patient empowerment. While the number of hospitals incorporating our solution has increased in recent years, there is a significant group of hospitals and physicians who have not yet adopted our solution, and additional hospitals and physicians may choose not to adopt our solution for a number of reasons, including:
•inadequate recruiting or training of talented sales force in existing and new markets to facilitate outreach and further adoption and awareness of Zephyr Valve;
•lack of experience with our solution and the Zephyr Valve as a treatment alternative;
•the failure of key opinion leaders to continue to provide recommendations regarding the Zephyr Valve, or to assure physicians, patients and healthcare payors of the benefits of the Zephyr Valve as an attractive alternative to other treatment options;
•perceived inadequacy of evidence supporting clinical benefits or cost-effectiveness of our solution over existing alternatives;
•a perception among some physicians of patients’ inability to tolerate the procedure required to implant our solution;
•liability risks generally associated with the use of new products and procedures;
•the training required to use new products;
•lack of availability of adequate third-party payor coverage or reimbursement;
•access to hospital bidding processes;
•a decrease or delay in the number of procedures performed using our solution as a result of the COVID-19 pandemic;
•competing products and alternatives; and
•introduction of other novel alternative therapies to treat severe emphysema.
We focus our sales, marketing and training efforts primarily on pulmonologists. However, physicians from other disciplines, including primary care physicians, as well as other medical professionals, such as nurse practitioners, respiratory technicians, radiologists and community physicians, are often the initial point of contact for patients with severe emphysema.
55
These physicians and other medical professionals commonly screen and treat patients with severe emphysema, and are likely to recommend medical management, inhaled medications, pulmonary rehabilitation and supplemental oxygen, or more invasive LVRS or lung transplantations. We believe that educating physicians in these disciplines and other medical professionals about the clinical merits and patient benefits of our solution as a minimally invasive treatment for severe emphysema is a key element of increasing the adoption of our solution. If additional physicians or other medical professionals do not adopt, or existing physician customers cease referring patients to, our solution for any reason, including those listed above, our ability to execute our growth strategy will be impaired, and it will negatively affect our business, financial condition and results of operations.
In addition, patients will not qualify for our solution if, among other potential reasons, their lung anatomy has collateral ventilation that does not allow for effective treatment with the Zephyr Valve. Patients may not adopt our solution if they are reluctant to undergo a minimally invasive procedure, if they are worried about potential adverse effects of our solution, such as infection, discomfort or weakness, or if they are unable to obtain adequate third-party coverage or reimbursement.
If we fail to receive access to hospital facilities, our sales may decrease.
In the United States, in order for physicians to use the Zephyr Valve, we expect that the hospital facilities where these physicians treat patients will typically require us to enter into purchasing contracts setting forth the terms and conditions under which the hospital facilities will purchase Zephyr Valves. This process can be lengthy and time-consuming and require extensive negotiations and management time, and potentially result in delays and increases to the sales cycle before we can sell the Zephyr Valve to these hospitals. In the European Union, certain institutions may require us to engage in a contract bidding process in the event that such institutions are considering making purchase commitments that exceed specified cost thresholds, which vary by jurisdiction. These processes are only open at certain periods of time, and we may not be successful in the bidding process. If we do not receive access to hospital facilities via these contracting processes or otherwise, or if we are unable to secure contracts or tender successful bids, our sales may decrease, and our operating results may be harmed. Furthermore, we may expend significant effort in these time-consuming processes and still may not obtain a purchase contract from such hospitals.
A pandemic, epidemic or outbreak of an infectious disease in the United States or worldwide, including the outbreak of the novel strain of coronavirus disease, COVID-19, has had a material adverse impact on our business.
If a pandemic, epidemic or outbreak of an infectious disease occurs in the United States or worldwide, our business may be adversely affected. In December 2019, a novel strain of coronavirus, SARS-CoV-2, was identified in Wuhan, China. Since then, SARS-CoV-2, and the resulting disease, COVID-19, has spread to most countries and all 50 states within the United States. The COVID-19 pandemic has had a material adverse impact on our business, financial condition and results of operations by decreasing and delaying substantially all procedures performed using our products, and we expect the pandemic to continue to adversely impact our business, financial condition and results of operations for the foreseeable future. Similar to the general trend in elective and other surgical procedures, the number of procedures performed using our products has decreased substantially as healthcare organizations across the globe have prioritized the treatment of patients with COVID-19 or have altered their operations to prepare for and respond to the pandemic. For example, in the United States, governmental authorities have recommended, and, in certain cases, required, that elective, specialty and other procedures and appointments be suspended or canceled to avoid non-essential patient exposure to medical environments and potential infection with COVID-19 and to focus limited resources and personnel capacity toward the treatment of COVID-19 patients. The COVID-19 pandemic has also adversely impacted the number of procedures using the Zephyr Valve as hospitals have had to, and continue to, focus on COVID-19 and as patients generally sought to postpone healthcare visits and treatments. Specifically, beginning in the second half of March 2020, procedures using our products were temporarily postponed or cancelled as COVID-19 spread to the various regions across the globe where we conduct our business and sell our products. Beginning in May 2020, we began to see signs of a recovery in our business, and by September 30, 2020 the total number of Zephyr Valves sold in the third quarter exceeded the total number of Zephyr Valves sold during the first quarter of 2020. In November and December 2020, a resurgence of COVID-19 led to a
56
decrease in procedure volumes and our revenues in the fourth quarter of 2020 declined compared to revenues in the third quarter of 2020. Our sales continued to be impacted by COVID-19 in January and February 2021. The COVID-19 driven impact on procedure volumes extended through the first two months of 2021. We have seen initial indicators in March 2021 that the resurgence of COVID-19 is diminishing and we anticipate improving sales during 2021, assuming the efficacy, availability and delivery of vaccines as well as other societal responses to the pandemic. Despite these signs of recovery of or business, we cannot be certain that any recovery will be sustained, or that a further resurgence of COVID-19 will not occur in 2021. We believe many of the measures adopted in response to, and challenges resulting, from COVID-19 will likely continue for the duration of the pandemic, which is uncertain, and are expected to continue to significantly reduce our revenue and adversely impact our business, financial condition and results of operations for the duration of the pandemic. As a result, we cannot assure you that our recent volume of Zephyr Valves sold are indicative of future results or that we will not experience additional adverse or materially adverse impacts associated with the COVID-19 pandemic. The number of Zephyr Valves sold in the future may decrease as the backlog of patients who have cancelled or postponed their procedures due to the pandemic is reduced. The COVID-19 pandemic has adversely impacted our business, financial condition and results of operations by significantly decreasing and delaying the number of procedures performed using our products, and we expect the pandemic to continue to adversely impact our business, financial condition and results of operations. Further, once the COVID-19 pandemic subsides, there may be a substantial backlog of patients seeking appointments with physicians and surgeries to be performed at hospitals relating to a variety of medical conditions, and as a result, patients seeking treatment with Zephyr Valves may have to navigate limited provider capacity. We believe this limited provider and hospital capacity could have a material adverse effect on our business, financial condition and results of operations once the pandemic subsides and following the end of the pandemic.
Numerous state and local jurisdictions imposed, and others in the future may impose, “shelter-in-place” orders, quarantines, executive orders and similar government orders and restrictions for their residents to control the spread of COVID-19. On March 19, 2020, the governor of California, where our headquarters are located, issued “stay at home” orders limiting non-essential activities, travel and business operations. Such orders or restrictions have resulted in reduced operations at our headquarters (including our manufacturing facility), work stoppages, slowdowns and delays, travel restrictions and cancellation of events and have restricted the efforts of our sales representatives, thereby significantly and negatively impacting our operations. Other disruptions or potential disruptions include restrictions on the ability of our sales representatives and other personnel to travel and access customers for training and case support; inability of our suppliers to manufacture components and parts and to deliver these to us on a timely basis, or at all; disruptions in our production schedule and ability to manufacture and assemble products; inventory shortages or obsolescence; delays in actions of regulatory bodies; delays in clinical trials and studies; diversion of or limitations on employee resources that would otherwise be focused on the operations of our business, including because of sickness of employees or their families or the desire of employees to avoid contact with groups of people; delays in growing or reductions in our sales organization, including through delays in hiring, lay-offs, furloughs or other losses of sales representatives; restrictions in our ability to ship our products to customers; business adjustments or disruptions of certain third parties, including suppliers, medical institutions and clinical investigators with whom we conduct business; negative impact on our customers’ credit profiles, which may adversely impact our future collection experience; and additional government requirements or other incremental mitigation efforts that may further impact our or our suppliers’ capacity to manufacture our products. The extent to which the COVID-19 pandemic impacts our business will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity and spread of COVID-19 and the actions to contain COVID-19 or treat its impact, among others.
While the potential economic impact brought by and the duration of any pandemic, epidemic or outbreak of an infectious disease, including COVID-19, may be difficult to assess or predict, the widespread COVID-19 pandemic has resulted in, and may continue to result in, significant disruption of global financial markets, reducing our ability to access capital, which could in the future negatively affect our liquidity. In addition, the recession and market correction resulting from the spread of an infectious disease, including COVID-19, has materially affected our business. Such economic recession could have a material adverse effect on our long-term business as hospitals curtail and reduce capital and overall spending. In addition, the current economic downturn is resulting in significant job losses and reductions in disposable income and if patients are unable to obtain or maintain health insurance policies, this may significantly impact their ability to pay for the procedures utilizing our products, further
57
negatively impacting our business, financial condition and results of operations. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in this “Risk Factors” section.
Use of our solution requires appropriate physician training, and inadequate training may lead to negative patient outcomes and negatively affect our business, financial condition and results of operations.
The successful implantation of the Zephyr Valve depends in part on the training and skill of the physician performing the procedure and on adherence to appropriate patient selection and proper techniques provided in training sessions conducted by our training faculty. For example, we train physicians to ensure correct patient selection and treatment planning using the StratX Platform and Chartis System, and proper placement of the Zephyr Valve. Physicians could experience difficulty with the technique necessary to successfully implant the valve and may not achieve the technical competency necessary to complete the training program, or they could fail to properly learn how to interpret our StratX Platform or Chartis System. Moreover, physicians rely on their previous medical training and experience when using our solution, and we cannot guarantee that all such physicians will have the necessary skills to properly identify ideal candidates and to perform the procedure. We do not control which physicians use our solution or how much training they receive, and physicians who have not completed our training sessions may nonetheless attempt to use our solution. If physicians implant the Zephyr Valve incorrectly, or do so in a manner that is inconsistent with its labeled indications, with components that are not our products, in patients who are not good candidates, or without adhering to or completing our training sessions, their patient outcomes may not be consistent with the outcomes achieved in our clinical trials. This result may negatively impact the perception of patient benefit and safety, and limit adoption of our solution as a treatment for severe emphysema and our products that facilitate the procedure, which will negatively affect our business, financial condition and results of operations.
In addition, we may experience difficulty growing the number of physicians who complete our training program if patient demand is low, if the length of time necessary to train each physician is longer than expected, if the capacity of our commercial organization to train physicians is less than expected or if we are unable to sufficiently grow our sales force. All these events would lead to fewer trained physicians qualified to implant the Zephyr Valve, which could negatively affect our business, financial condition and results of operations.
Use of the Zephyr Valve involves risks and may result in complications, including pneumothorax or death, and is contraindicated in certain patients, which may limit adoption and negatively affect our business, financial condition and results of operations.
The most common serious complications relating to the use of the Zephyr Valve include pneumothoraces, worsening of COPD symptoms, hemoptysis, pneumonia, dyspnea, respiratory failure and, in rare cases, death. Pneumothoraces occur when a lung collapses due to an air leak inside the lung and may result from rapid shifts in air volume in the chest as the target lobe deflates and the neighboring lobe expands following the Zephyr Valve treatment. A pneumothorax typically requires placement of a chest tube to manage the air leak. While most pneumothoraces can be readily managed with standard medical care, in rare cases they can be life-threatening, particularly if left untreated. In the event the pneumothorax does not resolve with standard management, one or more valves can be removed to re-inflate the lung; these are typically replaced later when the pneumothorax has resolved.
In our clinical trials, pneumothoraces occurred in 18-34% of patients treated with the Zephyr Valve, and in the LIBERATE study, 17% of the pneumothorax events required no intervention and resolved on their own. Patients who have had their pneumothoraces successfully treated had comparable outcomes to those who did not experience a pneumothorax, other than that their hospital stays were extended by approximately a week compared to the three nights for patients without pneumothoraces.
In the LIBERATE study, the majority of pneumothoraces (76%) occurred within three days following a bronchoscopy procedure. During the Treatment Period (day of procedure to 45 days), there were a total of four deaths (3.1%) in the Zephyr Valve Group (which received Zephyr Valves plus medical management) and none in the Control Group (which received medical management alone). Three of the four deaths were deemed by the investigators to be definitely related to treatment with Zephyr Valves and the remaining one was deemed by the
58
investigators to be probably related to treatment with Zephyr Valves. Each patient that died experienced pneumothorax, with three deaths directly attributed to the pneumothorax and the fourth death the result of respiratory failure, after the pneumothorax had resolved. Two of the pneumothorax-related deaths occurred early in the study when patients were being kept in the hospital for one night after the procedure. In order to more closely monitor patients, the study protocol was subsequently amended to keep patients in the hospital for five nights. Based on the full study data, current practice is to keep patients in the hospital for a minimum of three nights post-treatment. Post-hoc analysis has helped to identify risk factors for the group of patients at a higher risk of having a complex pneumothorax event (complex pneumothorax defined as requiring removal of all valves or resulting in death) should one occur. Such high-risk patients include those who are not treated in the most diseased lobe and have greater than 60% destruction of the untreated lung. All four patients who experienced a pneumothorax and died were within this high-risk group. This learning is incorporated in our physician training program for physicians to identify such high-risk patients and to consider alternative targets or other risk mitigation strategies. During the Longer-Term Period (46 days after procedure to 12 months), there was one death (0.8%) in the Zephyr Valve Group from a COPD exacerbation, deemed by the investigators not to be related to treatment with Zephyr Valves, and one cardiac arrhythmia related death in the Control Group (1.6%).
Outside of clinical trials, patients treated with the Zephyr Valve have also experienced serious complications, including pneumothoraces and death related to the Zephyr Valve.
Serious complications as a result of treatment with Zephyr Valves, and any increase in the rate of complications in or outside of clinical trials, could cause doctors, hospitals and patients to limit adoption of our solution and subject us to costly litigation, require us to pay substantial amounts of money to patients, delay, negatively impact or end our opportunity to receive or maintain regulatory approval to market our products, or require us to suspend or abandon our commercialization efforts, which may negatively impact adoption as well as our business, financial condition and results of operations. Even in a circumstance in which we do not believe that a complication is related to the Zephyr Valve or treatment with the Zephyr Valve, the investigation into the circumstance may be time-consuming or inconclusive and may interrupt our sales efforts or impact and limit the type of regulatory approvals the Zephyr Valve receives or maintains and any related claims may negatively impact adoption as well as our business, financial condition and results of operations. Moreover, perceptions regarding the safety of the Zephyr Valve could be affected even if such complications are unrelated to the Zephyr Valve or treatment with the Zephyr Valve.
Further, our current products are contraindicated, and therefore should not be used, in certain patients, including those for whom bronchoscopic procedures are contraindicated, with evidence of active pulmonary infection, with known allergies to Nitinol (nickel-titanium) or its constituent metals (nickel or titanium) or silicone, who have not quit smoking, or with large bullae encompassing greater than 30% of either lung, and such contraindication may limit adoption and, as a result, negatively impact our business, financial condition and results of operations.
If we are unable to achieve and maintain adequate levels of coverage or reimbursement for our solution, or any future products we may seek to commercialize, or if patients are left with significant out-of-pocket costs, our commercial success may be severely hindered.
We currently derive substantially all of our revenue from the sale of our products to hospitals and distributors and expect this to continue for the foreseeable future. We primarily sell Zephyr Valves through a direct sales force that primarily engages with pulmonologists in the United States, Europe and Asia Pacific. Hospitals typically bill various third-party payors to cover all or a portion of the costs and fees associated with the procedures in which our solution is used and bill patients for any deductibles or co-payments. As of December 31, 2020, commercial payors such as Aetna, Humana, Health Care Service Corporation, Highmark, Priority Health and Emblem Health have issued positive coverage policies for endobronchial valve procedures. United Healthcare removed the endobronchial valve codes from their non-covered list, and as such no longer considers the procedure unproven or experimental. Other commercial payors, including other plans in the Blue Cross Blue Shield family of plans, do not yet consider our solution medically necessary. Medicare, currently without a public coverage policy, covers our solution for patients when medically necessary on a case-by-case basis, and other commercial insurers not described above are approving pre-authorization requests on a case-by-case basis.
59
The Centers for Medicare & Medicaid Services (CMS) have established guidelines for the coverage and reimbursement of certain products and procedures by Medicare. In general, in order to be reimbursed by Medicare, a healthcare procedure furnished to a Medicare beneficiary must be reasonable and necessary for the diagnosis or treatment of an illness or injury, or to improve the functioning of a malformed body part. The methodology for determining coverage status and the amount of Medicare reimbursement varies based upon, among other factors, the setting in which a Medicare beneficiary received healthcare products and services. Any changes in federal legislation, regulations and policy affecting CMS coverage and reimbursement relative to the procedure using our products could have a material effect on our performance. While no national coverage determination (NCD) or local coverage determination (LCD) exists for endobronchial valves currently, CMS could develop an NCD, or one or more Medicare contractors could develop an LCD that either restricts coverage or restricts the patient population deemed appropriate for the treatment.
Physicians that insert the Zephyr Valve, or the hospitals for which they work, may be subject to reimbursement claim denials upon submission of the claim. Physicians or hospitals may also be subject to recovery of overpayments if a payor makes payment for the claim and subsequently determines that the payor’s coding, billing or coverage policies were not followed. Whenever possible, pre-authorization for coverage for the procedure is recommended before the procedure is performed. When pre-authorization is not obtained or not allowed, and the procedure is performed and not covered by third-party payors, physicians or hospitals typically directly bill patients enrolled with these third-party payors for the costs and fees associated with the procedures in which our products are used. Moreover, because there is often no separate reimbursement for supplies used in surgical procedures, the additional cost associated with the use of our solution can affect the profit margin of the hospital or surgery center where the procedure is performed. Some of our target physicians and hospitals may be unwilling to adopt our products in light of the additional associated cost. Further, any decline in the amount payors are willing to reimburse physicians and hospitals could make it difficult for existing physicians and hospitals to continue using or to adopt our solution and could create additional pricing pressure for us. If we are forced to lower the price we charge for our solution, our gross margins will decrease, which will negatively affect our business, financial condition and results of operations.
Outside of the United States, reimbursement levels vary significantly by country and by patient. Reimbursement is obtained from a variety of sources, including government sponsors, hospital budgets, or private health insurance plans, or combinations thereof. We have established reimbursement access in countries across Europe and Asia Pacific, including Australia, Belgium, France, Germany, the Netherlands, South Korea, the United Kingdom and other countries. Even if we succeed in bringing our products to market in additional foreign countries, uncertainties regarding future healthcare policy, legislation and regulation, as well as private market practices, could affect our ability to sell our products in commercially acceptable quantities at acceptable prices.
Third-party payors, whether foreign or domestic, or governmental or commercial, are developing increasingly sophisticated methods of controlling healthcare costs. In addition, no uniform policy of coverage and reimbursement for procedures using our solution exists among third-party payors. Therefore, coverage and reimbursement for procedures using our products can differ significantly from payor to payor. Payors continually review new and existing technologies for possible coverage and can, without notice, deny or reverse coverage for new or existing products and procedures. There can be no assurance that third-party payor policies will provide coverage for procedures in which our products are used. If we are not successful in reversing existing non-coverage policies, if third-party payors that currently cover or reimburse our products and related procedures reverse or limit their coverage in the future or if other third-party payors issue similar policies, this will negatively affect our business, financial condition and results of operations. Further, coverage policies and third-party payor reimbursement rates may change at any time. Therefore, even if favorable coverage is established on one or more products for which we receive regulatory approval, less favorable coverage policies and reimbursement rates may be implemented in the future.
Further, we believe that future coverage and reimbursement may be subject to increased restrictions, such as additional prior authorization requirements, both in the United States and in international markets. Third-party coverage and reimbursement for procedures using our solution or any of our products in development for which we may receive regulatory approval may not be available or adequate in either the United States or international markets, which will negatively affect our business, financial condition and results of operations.
60
Third-party payors and physicians who do not cover or use the Zephyr Valve may require additional clinical data prior to maintaining coverage of or adopting the Zephyr Valve.
Our success depends on physician and third-party payor acceptance of our solution as an effective treatment option for patients with severe emphysema. If physicians or payors do not find our body of published clinical evidence and data compelling or wish to wait for additional studies, they may choose not to use or provide coverage and reimbursement for our solution.
In addition, the long-term effects of use of the Zephyr Valve to treat severe emphysema are not yet known. Certain physicians, hospitals and payors may prefer to see longer-term safety and efficacy data published than we have produced. Further, we cannot provide assurance that any data that we or others may generate in the future will be consistent with that observed in our existing clinical studies.
If we fail to retain marketing and sales personnel and, as we grow, fail to increase our marketing and sales capabilities or develop broad awareness of our solution in a cost-effective manner, we may not be able to generate revenue growth.
We have limited experience marketing and selling our solution. We currently rely on our direct sales force to sell our solution in targeted geographic regions and distributors in certain regions outside the United States, and any failure to maintain and grow our direct sales force will negatively affect our business, financial condition and results of operations. The members of our direct sales force are highly trained and possess substantial technical expertise, which we believe is critical in increasing adoption of our solution. The members of our U.S. sales force are at-will employees. The loss of these personnel to competitors, or otherwise, will negatively affect our business, financial condition and results of operations. If we are unable to retain our direct sales force personnel or replace them with individuals of equivalent technical expertise and qualifications, or if we are unable to successfully instill such technical expertise in replacement personnel, it may negatively affect our business, financial condition and results of operations.
In order to generate future growth, we plan to continue to expand and leverage our sales and marketing infrastructure to increase the number of customers and emphysema centers of excellence. Identifying and recruiting qualified sales and marketing personnel and training them on our solution, on applicable federal and state laws and regulations and on our internal policies and procedures requires significant time, expense and attention. It often takes several months or more before a sales representative is fully trained and productive. Our sales force may subject us to higher fixed costs than those of companies with competing techniques or products that utilize independent third parties, which could place us at a competitive disadvantage. It will negatively affect our business, financial condition and results of operations if our efforts to expand and train our sales force do not generate a corresponding increase in revenue, and our higher fixed costs may slow our ability to reduce costs in the face of a sudden decline in demand for our solution. Any failure to hire, develop and retain talented sales personnel, to achieve desired productivity levels in a reasonable period of time or timely reduce fixed costs, could negatively affect our business, financial condition and results of operations. Our ability to increase our customer base and achieve broader market acceptance of our solution will depend to a significant extent on our ability to expand our marketing efforts. We plan to dedicate significant resources to our marketing programs. It will negatively affect our business, financial condition and results of operations if our marketing efforts and expenditures do not generate a corresponding increase in revenue. In addition, we believe that developing and maintaining broad awareness of our solution in a cost-effective manner is critical to achieving broad acceptance of our solution and expanding domestically and internationally. Promotion activities may not generate patient or physician awareness or increase revenue, and even if they do, any increase in revenue may not offset the costs and expenses we incur in building our brand. If we fail to successfully promote, maintain and protect our brand, we may fail to attract or retain the physician acceptance necessary to realize a sufficient return on our brand building efforts, or to achieve the level of brand awareness that is critical for broad adoption of our solution.
We have limited long-term data regarding the safety and effectiveness of our solution, including the Zephyr Valve. The only safety and effectiveness data of our solution, including the Zephyr Valve, is limited to one year
61
following placement and we are required to conduct extension studies to follow up on safety and effectiveness out to five years.
Although we have demonstrated the safety, effectiveness and clinical advantages of our solution in multiple clinical trials in approximately 450 patients selected using the Chartis System, the Zephyr Valve is still a relatively new treatment for severe emphysema. The long-term effects of using our solution in a large number of patients have not been studied and the results of short-term clinical use of such products do not necessarily predict long-term clinical benefits or reveal long-term adverse effects. We are required to conduct the LIBERATE extension study to follow up on safety and effectiveness out to five years. After the completion of the one-year follow up, 115 Zephyr Valve patients and 47 crossover patients (162 total patients) entered the LIBERATE extension study. The results of this extension study will not be available until February 2023. Our ability to interpret the data from this long-term follow-up of patients with this progressive disease may be limited by the fact that the matched control group exited the study after one year. The results of clinical trials of our solution conducted to date and ongoing or future studies and trials of our current, planned or future products may not be predictive of the results of later clinical trials, and interim results of a clinical trial do not necessarily predict final results. Our interpretation of data and results from our clinical trials do not ensure that we will achieve similar results in future clinical trials in other patient populations. In addition, pre-clinical and clinical data are often susceptible to various interpretations and analyses, and many companies that have believed their products performed satisfactorily in pre-clinical studies and earlier clinical trials have nonetheless failed to replicate results in later clinical trials and subsequently failed to obtain marketing approval. Products in later stages of clinical trials may fail to show the desired safety and efficacy despite having progressed through nonclinical studies and earlier clinical trials.
The continuing development of our products depends upon our maintaining strong working relationships with physicians.
The research, development, marketing and sale of our current products and potential new and improved products or future product indications for which we receive regulatory clearance or approval depend upon our maintaining working relationships with physicians. We rely on these professionals to provide us with considerable knowledge and experience regarding the development, marketing and sale of our products. Physicians assist us in clinical trials and in marketing, and as researchers, product consultants and public speakers. If we cannot maintain our strong working relationships with these professionals and continue to receive their advice and input, the development and marketing of our products could suffer, which could negatively affect our business, financial condition and results of operations. At the same time, the medical device industry’s relationship with physicians is under increasing scrutiny by the U.S. Department of Health and Human Services Office of Inspector General (OIG), the U.S. Department of Justice (DOJ), the state attorneys general and other foreign and domestic government agencies. Our failure to comply with requirements governing the industry’s relationships with physicians or an investigation into our compliance by the OIG, the DOJ, state attorneys general and other government agencies, could negatively affect our business, financial condition and results of operations. Additional information regarding the laws impacting our relationships with physicians and other healthcare professionals can be found below under “Risks Related to Government Regulation and Our Industry.”
We rely on third parties to perform certain aspects of the CT scan analysis within the StratX Platform.
We rely on third-party service providers to upload and analyze CT scan data on the StratX Platform. In order to make the StratX Platform available to physicians, we contract with a third-party cloud service. This third-party cloud service enables physicians to upload CT scan data while removing protected health information (PHI) of patients from that data, in case the physicians have, inadvertently, not removed the PHI themselves. We also contract with additional third-party service providers to analyze the CT scan data using their proprietary software, and provide quantitative results via an easy-to-read report that we designed for our solution (StratX Lung Report). The StratX Lung Report is then made available to physicians in the third-party cloud service.
This service is critical and there are relatively few alternatives. These third-party service providers may be unwilling or unable to provide the necessary services reliably and at the levels we anticipate or that are required by the market. While these third-party service providers have generally met our demand for their services on a timely basis in the
62
past, we cannot guarantee that they will in the future be able to meet our demand for their services, either because of acts of nature, the nature of our agreements or potential disputes with those service providers or our relative importance to them as a customer, and our service providers may decide in the future to discontinue or reduce the level of business they conduct with us. If we are required to change service providers for any reason, including due to any change in or termination of our relationships with these third parties, we may lose sales, experience delays, incur increased costs or otherwise experience impairment to our customer relationships. We cannot guarantee that we will be able to establish alternative relationships on similar terms, without delay or at all.
We depend on a limited number of single-source suppliers to manufacture our products, which makes us vulnerable to supply shortages and price fluctuations that could negatively affect our business, financial condition and results of operations.
We rely on single-source suppliers for the components, sub-assemblies and materials for our products. These components, sub-assemblies and materials are critical and there are no or relatively few alternative sources of supply. These single-source suppliers may be unwilling or unable to supply the necessary materials and components or manufacture and assemble our products reliably and at the levels we anticipate or that are required by the market. While our suppliers have generally met our demand for their products and services on a timely basis in the past, we cannot guarantee that they will in the future be able to meet our demand for their products, either because of acts of nature, the nature of our agreements with those manufacturers or our relative importance to them as a customer, and our suppliers may decide in the future to discontinue or reduce the level of business they conduct with us. If we are required to change suppliers due to any change in or termination of our relationships with these third parties, or if our suppliers are unable to obtain the materials they need to produce our products at consistent prices or at all, we may lose sales, experience manufacturing or other delays, incur increased costs or otherwise experience impairment to our customer relationships. We cannot guarantee that we will be able to establish alternative relationships on similar terms, without delay or at all.
We have not qualified or obtained necessary regulatory approvals for additional suppliers for most of these components, sub-assemblies and materials, and we do not carry a significant inventory of these items. While we believe that alternative sources of supply may be available, we cannot be certain whether they will be available if and when we need them, or that any alternative suppliers would be able to provide the quantity and quality of components and materials that we would need to manufacture our products if our existing suppliers were unable to satisfy our supply requirements. To utilize other supply sources, we would need to identify and qualify new suppliers to our quality standards and obtain any additional regulatory approvals required to change suppliers, which could result in manufacturing delays and increase our expenses.
Although we require our third-party suppliers to supply us with components that meet our specifications and comply with applicable provisions of the FDA’s Quality System Regulation (QSR) and other applicable legal and regulatory requirements in our agreements and contracts, and we perform incoming inspection, testing or other acceptance activities to ensure the components meet our requirements, there is a risk that our suppliers will not always act consistent with our best interests, and may not always supply components that meet our requirements or supply components in a timely manner.
We have limited experience manufacturing our products in significant commercial quantities and we face manufacturing risks that may adversely affect our ability to manufacture our products, reduce our gross margins and negatively affect our business, financial condition and results of operations.
Our business strategy depends on our ability to manufacture our current and future products in sufficient quantities and on a timely basis to meet customer demand, while adhering to product quality standards, complying with regulatory quality system requirements and managing manufacturing costs. We have a facility located in Redwood City, California, where we assemble, inspect, package, release and ship our products. We currently produce the Zephyr Valve and Chartis System at this facility, and we do not have redundant facilities. We also store finished goods at secondary facilities in Redwood City, California, Memphis, Tennessee and the Netherlands. If these facilities suffer damage, or a force majeure event, this could materially impact our ability to operate.
63
We are also subject to numerous other risks relating to our manufacturing capabilities, including:
•quality and reliability of components, sub-assemblies and materials that we source from third-party suppliers, that are required to meet our quality specifications, many of whom are our single source suppliers for the products they supply;
•our inability to secure components, sub-assemblies and materials in a timely manner, in sufficient quantities or on commercially reasonable terms;
•our inability to maintain compliance with quality system requirements or pass regulatory quality inspections;
•disruptions in our production schedule and ability to manufacture and assemble products due to the COVID-19 pandemic;
•our failure to increase production capacity or volumes to meet demand;
•our inability to design or modify production processes to enable us to produce future products efficiently or implement changes in current products in response to design or regulatory requirements; and
•difficulty identifying and qualifying, and obtaining new regulatory approvals, for alternative suppliers for components in a timely manner.
These risks are likely to be exacerbated by our limited experience with our current products and manufacturing processes. As demand for our solution increases, we will have to invest additional resources to purchase components, sub-assemblies and materials, hire and train employees and enhance our manufacturing processes. If we fail to increase our production capacity efficiently, we may not be able to fill customer orders on a timely basis, our sales may not increase in line with our expectations and our operating margins could fluctuate or decline. In addition, even if future products in development share product features, components, sub-assemblies and materials with our existing products, the manufacture of these products may require modification of our current production processes or unique production processes, the hiring of specialized employees, the identification of new suppliers for specific components, sub-assemblies and materials or the development of new manufacturing technologies. It may not be possible for us to manufacture these products at a cost or in quantities sufficient to make these products commercially viable or to maintain current operating margins, all of which will negatively affect our business, financial condition and results of operations.
Our results of operations will be materially harmed if we are unable to accurately forecast customer demand for our solution and manage our inventory.
To ensure adequate inventory supply, we must forecast inventory needs and manufacture the Zephyr Valve and Chartis System based on our estimates of future demand for our solution. Our ability to accurately forecast demand for our solution could be negatively affected by many factors, including our failure to accurately manage our expansion strategy, product introductions by competitors, an increase or decrease in customer demand for our solution or for products of our competitors, our failure to accurately forecast customer acceptance of new products, unanticipated changes in general market conditions or regulatory matters and weakening of economic conditions or consumer confidence in future economic conditions. Inventory levels in excess of customer demand may result in inventory write-downs or write-offs, which would cause our gross margin to be adversely affected and could impair the strength of our brand. Conversely, if we underestimate customer demand for our solution, our internal manufacturing team may not be able to deliver products to meet our requirements, and this could result in damage to our reputation and customer relationships. In addition, if we experience a significant increase in demand, additional supplies of raw materials or additional manufacturing capacity may not be available when required on terms that are acceptable to us, or at all, or suppliers or may not be able to allocate sufficient capacity in order to meet our increased requirements, which will negatively affect our business, financial condition and results of operations.
64
We seek to maintain sufficient levels of inventory in order to protect ourselves from supply interruptions. As a result, we are subject to the risk that a portion of our inventory will become obsolete or expire, which could have a material adverse effect on our earnings and cash flows due to the resulting costs associated with the inventory impairment charges and costs required to replace such inventory.
Our operating results may fluctuate significantly, which makes our future operating results difficult to predict and could cause our operating results to fall below expectations or any guidance we may provide.
Our quarterly and annual operating results may fluctuate significantly, which makes it difficult for us to predict our future operating results. Accordingly, the results of any one quarter or period should not be relied upon as an indication of future performance. Our quarterly and annual operating results may fluctuate as a result of a variety of factors, many of which are outside our control and, as a result, may not fully reflect the underlying performance of our business. These fluctuations may occur due to a variety of factors, many of which are outside of our control, including, but not limited to:
•the level of demand for our products and any future products, which may vary significantly;
•expenditures that we may incur to acquire, develop or commercialize additional products and technologies;
•the timing and cost of obtaining regulatory approvals or clearances for planned or future products or indications;
•unanticipated pricing pressures;
•the rate at which we grow our sales force and the speed at which newly hired salespeople become effective, and the cost and level of investment therein;
•our ability to expand the geographic reach of our sales force;
•the degree of competition in our industry and any change in the competitive landscape of our industry, including consolidation among our competitors or future partners;
•coverage and reimbursement policies with respect to our products, and potential future products that compete with our products;
•the timing and success or failure of pre-clinical studies or clinical trials for our products or any future products we develop or competing products;
•positive or negative coverage in the media or clinical publications of our products or products of our competitors or our industry;
•the timing of customer orders or medical procedures using our products and the number of available selling days in any quarterly period, which can be impacted by holidays, the mix of products sold and the geographic mix of where products are sold, including any related foreign currency impact;
•seasonality, including possible seasonal slowing of demand for our products in the beginning and end of the year and summer months based on the elective nature of procedures performed using our products, and which may become more pronounced in the future as our business grows;
•the ongoing and global impact that the COVID-19 pandemic had and may continue to have on our business and the number of patients treated with Zephyr Valves, or any other pandemic, epidemic or outbreak of an infectious disease;
65
•the timing and cost of, and level of investment in, research, development, licenses, regulatory approval, commercialization activities, acquisitions and other strategic transactions, or other significant events relating to our products, which may change from time to time;
•the cost of manufacturing our products, which may vary depending on the quantity of production and the terms of our agreements with third-party suppliers and manufacturers;
•the average number of Zephyr Valves used for a patient, pricing, discounts and incentives; and
•future accounting pronouncements or changes in our accounting policies.
The cumulative effects of these factors could result in large fluctuations and unpredictability in our quarterly and annual operating results. As a result, comparing our operating results on a period-to-period basis may not be meaningful. Further, our historical results are not necessarily indicative of results expected for any future period, and quarterly results are not necessarily indicative of the results to be expected for the full year or any other period, and accordingly should not be relied upon as indicative of future performance.
This variability and unpredictability could also result in our failing to meet the expectations of industry or financial analysts or investors for any period. If our revenue or operating results fall below the expectations of analysts or investors or below any forecasts we may provide to the market, it will negatively affect our business, financial condition and results of operations.
The sizes of the markets for our current and future products have not been established with precision and may be smaller than we estimate and may decline. Certain patients may not have regions of the lung with little to no collateral ventilation, making them poor candidates for the Zephyr Valve. In addition, if the overall rate of smokers continues to decline, this may eventually decrease the number of patients suffering from COPD and emphysema and, accordingly, who would benefit from our solution.
Our estimates of the annual total addressable markets for our current solution and products under development are based on a number of internal and third-party estimates, including, without limitation, the number of patients with severe emphysema treatable by our solution and the assumed prices at which we can sell our solution in markets that have not yet been established. While we believe our assumptions and the data underlying our estimates are reasonable, these assumptions and estimates may not be correct and the conditions supporting our assumptions or estimates may change at any time, thereby reducing the predictive accuracy of these underlying factors.
For example, certain of these patients may not have regions of the lung with little to no collateral ventilation, making them poor candidates for the Zephyr Valve. As a result, our estimates of the annual total addressable market for our current or future products may prove to be incorrect.
Further, cigarette smoking is one of the leading causes of COPD and emphysema. It is estimated that smoking accounts for as many as 80% of COPD-related deaths and 38% of the nearly 16 million adults in the United States diagnosed with COPD report being current smokers. The overall rate of smoking among the U.S. adult population has been steadily declining from 42.4% in 1965 to a record low of 13.7% in 2018 and there are increased efforts to decrease the rate of smoking globally. If the overall rate of smokers continues to decline, this may eventually decrease the number of patients suffering from COPD and emphysema and, accordingly, who would benefit from our solution.
If the actual number of patients who would benefit from our solution, the price at which we can sell future products, or the annual total addressable market for our solution is smaller than we have estimated, it may impair our sales growth and negatively affect our business, financial condition and results of operations.
66
Failure of a key information technology system, process, or site could negatively affect our business, financial condition and results of operations.
We depend on our information technology systems for the efficient functioning of our business, including the manufacture, distribution and maintenance of our products, as well as for accounting, data storage, compliance, purchasing and inventory management. We also depend on the information technology systems of third parties for the analysis, data storage and communication associated with the StratX Platform. We currently do not have redundant information technology systems. Our information technology systems, and those of third parties, may be subject to computer viruses, ransomware or other malware, attacks by computer hackers, failures during the process of upgrading or replacing software, databases or components thereof, power outages, damage or interruption from fires or other natural disasters, hardware failures, telecommunication failures and user errors, among other malfunctions. We, or the third parties we rely upon, could be subject to an unintentional event that involves a third party gaining unauthorized access to our or its systems, which could disrupt our operations, corrupt our data or result in release of our confidential information. Technological interruptions would disrupt our operations, including our ability to timely ship and track product orders, project inventory requirements, manage our supply chain and otherwise adequately service our customers or disrupt our customers’ ability use our products for treatments. Moreover, a disruption in access to the system that controls the StratX Platform would prevent physicians using our solution from receiving the StratX Lung Report indicating whether their patients are good candidates for the Zephyr Valve. In the event we experience significant disruptions, we may be unable to repair our systems in an efficient and timely manner. Accordingly, such events may disrupt or reduce the efficiency of our entire operation and negatively affect our business, financial condition and results of operations. Currently, we carry business interruption coverage to mitigate certain potential losses but this insurance is limited in amount, and we cannot be certain that such potential losses will not exceed our policy limits. Further, we do not carry any cyber insurance, which may expose us to certain potential losses for damages or result in penalization with fines in an amount exceeding our resources. We are increasingly dependent on complex information technology to manage our infrastructure. Our information systems require an ongoing commitment of significant resources to maintain, protect and enhance our existing systems. Failure to maintain or protect our information systems and data integrity effectively could negatively affect our business, financial condition and results of operations.
Litigation against us could be costly and time-consuming to defend and could result in additional liabilities.
We may from time to time be subject to legal proceedings and claims that arise in the ordinary course of business or otherwise, such as claims brought by our customers in connection with commercial disputes and employment claims made by our current or former employees. Claims may also be asserted by or on behalf of a variety of other parties, including government agencies, patients or vendors of our customers, or stockholders. For example, our Swiss subsidiary is currently party to a lawsuit with a former distributor outside the United States alleging that our Swiss subsidiary conducted unfair competitive practices and violated the exclusive distribution rights as a result of its termination of its distribution agreement. Our Swiss subsidiary is also currently party to a lawsuit with a former distributor outside the United States alleging that our Swiss subsidiary terminated the agreement without proper compensation. While we believe these claims are meritless and, if successful, we do not believe the impact of such claims will be material to the Company’s results of operations or financial position, an unfavorable outcome in this litigation could harm our business. Further, in the past, securities class action litigation has often been brought against a company following a decline in the market price of its securities, and this risk is especially relevant to industries that experience significant stock price volatility. Any litigation involving us may result in substantial costs, operationally restrict our business, and may divert management’s attention and resources, which may negatively affect our business, financial condition and results of operations.
We face the risk of product liability claims that would be expensive, divert management’s attention and harm our reputation and business. We may not be able to maintain adequate product liability insurance.
Our business exposes us to the risk of product liability claims that are inherent in the testing, manufacturing and marketing of medical devices. This risk exists even if a device is cleared or approved for commercial sale by the FDA and manufactured in facilities licensed and regulated by the FDA or an applicable foreign regulatory authority. The Zephyr Valve is designed to affect, and any future products will be designed to affect, important bodily
67
functions and processes. Any side effects, manufacturing defects, misuse or abuse associated with the Zephyr Valve could result in patient injury or death. The medical device industry has historically been subject to extensive litigation over product liability claims, and we cannot offer any assurance that we will not face product liability suits. There were procedure-related deaths in our LIBERATE Study and we may be subject to product liability claims if the Zephyr Valve causes, or merely appears to have caused, patient injury or death. In addition, an injury that is caused by the activities of our suppliers, such as those who provide us with components and raw materials, may be the basis for a claim against us. Product liability claims may be brought against us by patients, physicians, or others selling or otherwise coming into contact with the Zephyr Valve, among others. If we cannot successfully defend ourselves against product liability claims, we will incur substantial liabilities and reputational harm. In addition, regardless of merit or eventual outcome, product liability claims may result in:
•costs of litigation;
•distraction of management’s attention from our primary business;
•the inability to commercialize our solution or new products;
•decreased demand for our products;
•damage to our business reputation;
•product recalls or withdrawals from the market;
•withdrawal of clinical trial participants;
•substantial monetary awards to patients or other claimants; or
•loss of sales.
While we may attempt to manage our product liability exposure by proactively recalling or withdrawing from the market any defective products, any recall or market withdrawal of our products may delay the supply of those products to our customers and may impact our reputation. We can provide no assurance that we will be successful in initiating appropriate market recall or market withdrawal efforts that may be required in the future or that these efforts will have the intended effect of preventing product malfunctions and the accompanying product liability that may result. Such recalls and withdrawals may also be used by our competitors to harm our reputation for safety or be perceived by patients as a safety risk when considering the use of our solution, either of which could negatively affect our business, financial condition and results of operations.
Our insurance policies are expensive and protect us only from some business risks, which leaves us exposed to significant uninsured liabilities.
We do not carry insurance for all categories of risk that our business may encounter. Although we have product liability and clinical study liability insurance that we believe is appropriate, this insurance is subject to deductibles and coverage limitations. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if available, coverage may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at an acceptable cost or on acceptable terms or otherwise protect against potential product liability claims, we could be exposed to significant liabilities. A product liability claim, recall or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could negatively affect our business, financial condition and results of operations. We do not carry specific hazardous waste insurance coverage, and our property, casualty and general liability insurance policies specifically exclude coverage for damages and fines arising from hazardous waste exposure or contamination. Accordingly, in the event of contamination or injury, we could be held liable for damages or be penalized with fines in an amount exceeding our resources, and our clinical trials or regulatory approvals could be suspended. Additionally, we do not carry cyber
68
insurance, which may expose us to certain potential losses for damages or result in penalization with fines in an amount exceeding our resources.
We also expect that operating as a public company will make it more difficult and more expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. As a result, it may be more difficult for us to attract and retain qualified people to serve on our board of directors, on our board committees or as executive officers. We do not know, however, if we will be able to maintain existing insurance with adequate levels of coverage. Any significant uninsured liability may require us to pay substantial amounts, which would negatively affect our business, financial condition and results of operations.
Our indebtedness may limit our flexibility in operating our business and negatively affect our business, financial condition, results of operations and competitive position.
In February 2020, we terminated and paid off in full all amounts outstanding under the Oxford Agreement. In February 2020, we executed a Loan and Security Agreement (the CIBC Agreement) with Canadian Imperial Bank of Commerce (CIBC), which provided us with the ability to borrow up to $32.0 million in debt financing. As of December 31, 2020, we have borrowed $17.0 million under the CIBC Agreement. See the sections entitled "Management’s Discussion and Analysis of Financial Condition and Results of Operations⸺Liquidity and Capital Resources; Plan of Operation⸺2020 Notes", “Management’s Discussion and Analysis of Financial Condition and Results of Operations⸺Liquidity and Capital Resources; Plan of Operation⸺CIBC Term Loan" and the notes to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K.
In order to service this indebtedness and any additional indebtedness we may incur in the future, we need to generate cash from our operating activities. Our ability to generate cash is subject, in part, to our ability to successfully execute our business strategy, as well as general economic, financial, competitive, regulatory and other factors beyond our control. We cannot assure you that our business will be able to generate sufficient cash flow from operations or that future borrowings or other financings will be available to us in an amount sufficient to enable us to service our indebtedness and fund our other liquidity needs. To the extent we are required to use cash from operations or the proceeds of any future financing to service our indebtedness instead of funding working capital, capital expenditures or other general corporate purposes, we will be less able to plan for, or react to, changes in our business, industry and in the economy generally. This will place us at a competitive disadvantage compared to our competitors that have less indebtedness.
In addition, the CIBC Agreement contains, and any agreements evidencing or governing other future indebtedness may contain, certain covenants that limit our ability to engage in certain transactions that may be in our long-term best interests. Subject to certain limited exceptions, these covenants limit our ability to, among other things:
•convey, sell, lease, transfer, assign, dispose of or otherwise make cash payments consisting of all or any part of our business or property;
•effect certain changes in our business, management, ownership or business locations;
•merge or consolidate with, or acquire all or substantially all of the capital stock or assets of, any other company;
•create, incur, assume or be liable for any additional indebtedness, or create, incur, allow or permit to exist any additional liens;
•pay cash dividends on, make any other distributions in respect of, or redeem, retire or repurchase, any shares of our capital stock;
•make certain investments;
69
•enter into transactions with our affiliates; and
•under certain circumstances, settle pending or threatened litigation for greater amounts than are disclosed to CIBC in writing from time to time.
There can be no guarantee that we will not breach these covenants. Our ability to comply with these covenants may be affected by events and factors beyond our control. In the event that we breach one or more covenants, our lender may choose to declare an event of default and require that we immediately repay all amounts outstanding, terminate any commitment to extend further credit and foreclose on the collateral granted to it to collateralize such indebtedness. The occurrence of any of these events could negatively affect our business, financial condition and results of operations.
Our industry is highly competitive, and we may not be able to compete successfully with larger companies, companies with longer operating histories or more established products, or companies with greater resources.
Our industry is subject to rapid change from the introduction of new products and technologies and other activities of industry participants. Our goal is to establish our solution as a standard of care for severe emphysema. Existing treatments include medical management, LVRS, lung transplantation as well as other minimally invasive treatments. The major competitive products include the Spiration Valve System (Olympus Corporation) and the InterVapor System (Broncus Medical, Inc.; not approved for use in the United States). The Spiration Valve System is an endobronchial technology designed to offer patients with severe emphysema a minimally invasive treatment option for lung volume reduction by redirecting air away from diseased areas of the lung to healthier tissue so that patients may breathe easier. Like Zephyr Valves, the Spiration Valve System is indicated to treat patients with heterogeneous emphysema; however, the Spiration Valve System is contraindicated for patients with homogeneous emphysema. The InterVapor System offers a non-surgical and non-implant therapy developed for lung disease including emphysema and lung cancer where vapor ablation is simply the application of heated pure water to tissue. These technologies, other products that are in current clinical trials, new drugs or additional indications for existing drugs could demonstrate better safety, effectiveness, clinical results, lower costs or greater physician and patient acceptance.
We compete, or may compete in the future, against other companies which have longer operating histories, more established products and greater resources, which may prevent us from achieving significant market penetration or improved operating results. These companies enjoy several competitive advantages, including established relationships with pulmonologists who commonly treat patients with emphysema, significantly greater name recognition and significantly greater sales and marketing resources.
In addition to existing competitors, other larger and more established companies may acquire or in-license competitive products and could directly compete with us. These competitors may also try to compete with us on price both directly, through rebates and promotional programs to high volume physicians and coupons to patients, and indirectly, through attractive product bundling with complementary products that offer convenience and an effectively lower price compared to the total price of purchasing each product separately. Larger competitors may also be able to offer greater customer loyalty benefits to encourage repeat use of their products and finance a sustained global advertising campaign to compete with commercialization efforts of our products. Our competitors may seek to discredit our products by challenging our short operating history or relatively limited number of scientific studies and publications. Smaller companies could also launch new or enhanced products and services that we do not offer and that could gain market acceptance quickly. Additionally, certain of our competitors may challenge our intellectual property, may develop additional competing or superior technologies and processes and compete more aggressively and sustain that competition over a longer period of time than we could. Our technologies and products may be rendered obsolete or uneconomical by technological advances or entirely different approaches developed by one or more of our competitors. As more companies develop new intellectual property in our market, there is the possibility of a competitor acquiring patents or other rights that may limit our ability to update our technologies and products which may impact demand for our products.
70
We have increased the size of our organization and expect to further increase it in the future. If we are unable to manage the anticipated growth, our business, financial condition and results of operations will be negatively affected.
Any growth that we experience in the future will require us to expand our sales personnel and manufacturing operations and general and administrative infrastructure. As a public company, we will need to support managerial, operational, financial and other resources. In addition to the need to scale our organization, future growth will impose significant added responsibilities on management, including the need to identify, recruit, train and integrate additional employees. Rapid expansion in personnel could mean that less experienced people manufacture, market and sell our solution, which could result in inefficiencies and unanticipated costs, reduced quality and disruptions to our operations. In addition, rapid and significant growth may strain our administrative and operational infrastructure. Our ability to manage our business and growth will require us to continue to improve our operational, financial and management controls, reporting systems and procedures. If we are unable to manage our growth effectively, it may be difficult for us to execute our business strategy and negatively affect our business, financial condition and results of operations.
As demand for our solution or any of our future products increases, we will need to continue to scale our capacity, expand customer service, billing and systems processes and enhance our internal quality assurance program. We cannot assure you that any increases in scale, related improvements and quality assurance will be successfully implemented or that appropriate personnel will be available to facilitate the growth of our business. Failure to implement necessary procedures, transition to new processes or hire the necessary personnel could result in higher costs of processing data or inability to meet increased demand. If we encounter difficulty meeting market demand, quality standards or physician expectations, our reputation will be harmed and negatively affect our business, financial condition and results of operations.
We expect to continue to incur net losses for the next several years and we expect to require substantial additional capital to finance our planned operations, which may include future equity and debt financings. This additional capital may not be available to us on acceptable terms or at all. Our failure to obtain additional financing when needed on acceptable terms, or at all, could force us to delay, limit, reduce or eliminate our commercialization, sales and marketing efforts, product development programs or other operations.
Since inception, we have incurred significant net losses and expect to continue to incur net losses for the foreseeable future. Since our inception, our operations have been financed primarily through private placements of equity securities, debt financing arrangements and sales of our products. As of December 31, 2020, we had $231.6 million in cash and cash equivalents, and an accumulated deficit of $242.7 million. Based on our current planned operations, we expect our cash and cash equivalents, together with available borrowings under the CIBC Agreement, will enable us to fund our operating expenses for at least the next twelve months. We have based this estimate on assumptions that may prove to be wrong, and we could use our capital resources sooner than we currently expect.
We expect to continue to make substantial investments in clinical trials that are designed to provide clinical evidence of the safety and efficacy of our solution. We intend to continue to make significant investments in our sales and marketing organization by increasing the number of U.S. sales territory managers and expanding our international sales and marketing programs to help promote awareness and increase adoption of our solution primarily among the approximately 800 pulmonologists performing interventional pulmonary procedures across approximately 500 high volume hospitals. In order to continue to grow our business, we will need to hire additional sales personnel to efficiently serve the market. We also expect to continue to make investments in research and development, regulatory affairs and clinical studies to develop future generations of our solution, broaden the addressable market and expand indications, support regulatory submissions and demonstrate the clinical efficacy of our solution. Moreover, we expect to incur additional expenses associated with operating as a public company, including legal, accounting, insurance, exchange listing and Securities and Exchange Commission (SEC) compliance, investor relations and other expenses. Because of these and other factors, we expect to continue to incur substantial net losses
71
and negative cash flows from operations for the foreseeable future. Our future capital requirements will depend on many factors, including:
•the cost, timing and results of our clinical trials and regulatory reviews;
•the cost and timing of establishing sales, marketing and distribution capabilities;
•the impact of the COVID-19 pandemic on our business;
•the terms and timing of any other collaborative, licensing and other arrangements that we may establish;
•the timing, receipt and amount of sales from our current solution and potential future products;
•the degree of success we experience in continuing to commercialize our solution;
•the emergence of competing or complementary technologies;
•the cost of preparing, filing, prosecuting, maintaining, defending and enforcing any patent claims and other intellectual property rights; and
•the extent to which we acquire or invest in businesses, products or technologies, although we currently have no commitments or agreements relating to any of these types of transactions.
We will require additional financing to fund working capital and pay our obligations. We may seek to raise any necessary additional capital through a combination of public or private equity offerings or debt financings. There can be no assurance that we will be successful in acquiring additional funding at levels sufficient to fund our operations or on terms favorable to us. If adequate funds are not available on acceptable terms when needed, we may be required to significantly reduce operating expenses, which may negatively affect our business, financial condition and results of operations. If we do raise additional capital through public or private equity or convertible debt offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Additional capital may not be available on reasonable terms, or at all.
If the quality of our solution does not meet the expectations of physicians or patients, then our business and reputation may be harmed.
In the course of conducting our business, we must adequately address quality issues that may arise with our solution, including defects in third-party components included in our solution. Although we have established internal procedures designed to minimize risks that may arise from quality issues, there can be no assurance that we will be able to eliminate or mitigate occurrences of these issues and associated liabilities. In addition, even in the absence of quality issues, we may be subject to claims and liability if the performance of the Zephyr Valves does not live up to the expectations of physicians or patients as a result of the physician’s implantation of the valve. For example, a physician may improperly implant the Zephyr Valve. If the quality of our solution does not meet the expectations of physicians or patients, then our business and reputation with those physicians or patients may negatively affect our business, financial condition and results of operations.
If our facilities become damaged or inoperable, we will be unable to continue to research, develop and supply our solution which could negatively affect our business, financial condition and results of operations until we are able to secure a new facility and rebuild our inventory.
We do not have redundant facilities. We perform substantially all of our manufacturing, research and development and back office activity in a single location at our headquarters in Redwood City, California. We store our finished
72
goods inventory at our headquarters and secondary facilities in Redwood City, California, Memphis, Tennessee, and the Netherlands. Our facilities, equipment and inventory would be costly to replace and could require substantial lead time to repair or replace. The facilities will be harmed or rendered inoperable by natural or man-made disasters, including, but not limited to, earthquakes, flooding, fire and power outages, which may render it difficult or impossible for us to perform our research, development and commercialization activities for some period of time. The inability to perform those activities, combined with the time it may take to rebuild our manufacturing capabilities, inventory of finished product, may result in the loss of customers or harm to our reputation. Although we possess insurance for damage to our property and the disruption of our business, this insurance may not be sufficient to cover all of our potential losses and this insurance may not continue to be available to us on acceptable terms, or at all.
Performance issues, service interruptions or price increases by our shipping carriers could negatively affect our business, financial condition and results of operations and harm our reputation and the relationship between us and the hospitals with which we work.
Expedited, reliable shipping is essential to our operations. We rely heavily on providers of transport services for reliable and secure point-to-point transport of the Zephyr Valve and Chartis System to our customers and for tracking of these shipments. Should a carrier encounter delivery performance issues such as loss, damage or destruction of any systems, it would be costly to replace such systems in a timely manner and such occurrences may damage our reputation and lead to decreased demand for our solution and increased cost and expense to our business. In addition, any significant increase in shipping rates could adversely affect our operating margins and results of operations. Similarly, strikes, severe weather, natural disasters or other service interruptions affecting delivery services we use would adversely affect our ability to process orders for the Zephyr Valve on a timely basis.
We depend on our senior management team and the loss of one or more key employees or an inability to attract and retain highly skilled employees will negatively affect our business, financial condition and results of operations.
Our success depends in part on our continued ability to attract, retain and motivate highly qualified management, clinical and other personnel. We are highly dependent upon our management team, particularly our Chief Executive Officer, and the rest of our senior management, and other key personnel. Although we have entered into employment letter agreements with all of our executive officers, each of them may terminate their employment with us at any time. The replacement of any of our key personnel likely would involve significant time and costs and may significantly delay or prevent the achievement of our business objectives and could therefore negatively affect our business, financial condition and results of operations. In addition, we do not carry any key person insurance policies that could offset potential loss of service under applicable circumstances.
In addition, our research and development programs and clinical operations depend on our ability to attract and retain highly skilled engineers and medical researchers. We may not be able to attract or retain qualified engineers and medical researchers in the future due to the competition for qualified personnel. We have from time to time experienced, and we expect to continue to experience, difficulty in hiring and retaining employees with appropriate qualifications. Many of the companies with which we compete for experienced personnel have greater resources than us. If we hire employees from competitors or other companies, their former employers may attempt to assert that these employees or we have breached legal obligations, resulting in a diversion of our time and resources and, potentially, damages.
In addition, job candidates and existing employees, particularly in the San Francisco Bay Area, often consider the value of the stock awards they receive in connection with their employment. If the perceived value of our stock awards declines, it may harm our ability to recruit and retain highly skilled employees. Many of our employees have become or will soon become vested in a substantial amount of our common stock or a number of common stock options. Our employees may be more likely to leave us if the shares they own have significantly appreciated in value relative to the original purchase prices of the shares, or if the exercise prices of the options that they hold are significantly below the market price of our common stock, particularly after the expiration of the lock-up agreements described herein. Our future success also depends on our ability to continue to attract and retain
73
additional executive officers and other key employees. If we fail to attract new personnel or fail to retain and motivate our current personnel, it will negatively affect our business, financial condition and results of operations.
We have significant international operations, and to successfully market and sell our products in such international markets we must address international business risks with which we have limited experience.
Sales in markets outside of the United States accounted for approximately 50.5% and 67.2% of our revenue for the years ended December 31, 2020 and 2019, respectively. We currently focus our international sales and marketing efforts in Australia, Austria, Belgium, China, Denmark, France, Germany, Ireland, Italy, the Netherlands, South Korea, Spain, Switzerland and the United Kingdom. International sales are subject to a number of risks, including:
•difficulties in staffing and managing our international operations;
•increased competition as a result of more products and procedures receiving regulatory approval or otherwise free to market in international markets;
•longer accounts receivable payment cycles and difficulties in collecting accounts receivable;
•reduced or varied protection for intellectual property rights in some countries;
•export restrictions, trade regulations and foreign tax laws;
•fluctuations in currency exchange rates;
•foreign certification and regulatory clearance or approval requirements;
•difficulties in developing effective marketing campaigns in unfamiliar foreign countries;
•customs clearance and shipping delays;
•political, social, and economic instability abroad, global health epidemics or other contagious diseases (including the impact of the COVID-19 pandemic), terrorist attacks and security concerns in general;
•preference for locally produced products;
•potentially adverse tax consequences, including the complexities of foreign value-added tax systems, tax inefficiencies related to our corporate structure, and restrictions on the repatriation of earnings;
•differing payment and reimbursement regimes;
•the burdens of complying with a wide variety of foreign laws and different legal standards; and
•increased financial accounting and reporting burdens and complexities.
For example, the COVID-19 pandemic significantly decreased and may continue to have an adverse impact on the sale of our products and the number of patients treated with our solution. The outbreak has also resulted in disruptions or restrictions on physicians, hospitals and other healthcare providers from treating patients that are eligible for our products due to the uncertain health effects of the coronavirus on the respiratory system and resources that are diverted to prioritize treatment and containment of the coronavirus outbreak. In addition, the COVID-19 pandemic has also resulted in business closures and disruptions that may continue to affect various suppliers of ancillary products used in the delivery of our product (e.g. gowns, face masks or gloves), including disruptions and restrictions on transportation of our products and could result in significant delays. In addition, a significant outbreak of coronavirus and other contagious diseases could result in a widespread health crisis that
74
could adversely affect the economies and financial markets worldwide, resulting in an economic downturn that could affect demand for our products and impact our business, financial condition and results of operations.
If one or more of these risks are realized, it will negatively affect our business, financial condition and results of operations.
Security breaches, loss of data and other disruptions could compromise sensitive information related to our business or the physicians who use our solution and the patients they treat, or prevent us from assessing critical information and expose us to liability, which could negatively affect our business, financial condition and results of operations and our reputation.
In the ordinary course of our business, we may become exposed to, or collect and store sensitive data, including procedure-based information and legally PHI, credit card, and other financial information, insurance information, and other potentially personally identifiable information. For example, we may fail to remove all PHI from CT scan data on the StratX Platform. We also store sensitive intellectual property and other proprietary business information. Although we are in the process of implementing policies and procedures designed to ensure compliance with applicable data security and privacy-related laws and regulations and we take measures to protect sensitive information from unauthorized access or disclosure, our information technology (IT) and infrastructure, and other technology partners and providers, may be vulnerable to cyber-attacks by hackers or viruses or breaches due to employee error, malfeasance or other disruptions. We rely extensively on IT systems, networks and services, including internet sites, data hosting and processing facilities and tools, physical security systems and other hardware, software and technical applications and platforms, some of which are managed, hosted, provided or used by third-parties or their vendors, to assist in conducting our business. A significant breakdown, invasion, corruption, destruction or interruption of critical information technology systems or infrastructure, by our workforce, others with authorized access to our systems or unauthorized persons could negatively impact operations. The use of cloud-based computing creates opportunities for the unintentional dissemination or intentional destruction of confidential information stored in our or our third-party providers’ systems, portable media or storage devices. For example, companies have recently experienced an increase in phishing and social engineering attacks from third-parties. We could also experience a business interruption, theft of confidential information or reputational damage from industrial espionage attacks, malware or other cyber-attacks, which may compromise our system infrastructure or lead to data leakage, either internally or at our third-party providers and we do not carry cyber insurance, which may expose us to certain potential losses for damages or result in penalization with fines in an amount exceeding our resources. Although the aggregate impact on our operations and financial condition has not been material to date, we have occasionally been the target of events of this nature and expect them to continue as cybersecurity threats have been rapidly evolving in sophistication and becoming more prevalent in the industry. We are investing in protections and monitoring practices of our data and IT to reduce these risks and continue to monitor our systems on an ongoing basis for any current or potential threats. We cannot assure you, however, that our efforts will prevent breakdowns or breaches to our or our third-party providers’ databases or systems, and such breakdowns and breaches could negatively affect our business, financial condition and results of operations and our reputation.
We may enter into collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships with third parties that may not result in the development of commercially viable products, product improvements or the generation of significant future revenues.
In the ordinary course of our business, we may enter into collaborations, in-licensing arrangements, joint ventures, strategic alliances, partnerships or other arrangements to develop new products or product improvements and to pursue new markets. Proposing, negotiating and implementing collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships may be a lengthy and complex process. Other companies, including those with substantially greater financial, marketing, sales, technology or other business resources, may compete with us for these opportunities or arrangements. We may not identify, secure, or complete any such transactions or arrangements in a timely manner, on a cost-effective basis, on acceptable terms or at all. We have limited institutional knowledge and experience with respect to these business development activities, and we may also not realize the anticipated benefits of any such transaction or arrangement. In particular, these collaborations may not
75
result in the development of products that achieve commercial success or viable product improvements or result in significant revenues and could be terminated prior to developing any products.
Additionally, we may not be in a position to exercise sole decision making authority regarding the transaction or arrangement, which could create the potential risk of creating impasses on decisions, and our future collaborators may have economic or business interests or goals that are, or that may become, inconsistent with our business interests or goals. It is possible that conflicts may arise with our collaborators, such as conflicts concerning the achievement of performance milestones, or the interpretation of significant terms under any agreement, such as those related to financial obligations or the ownership or control of intellectual property developed during the collaboration. If any conflicts arise with any future collaborators, they may act in their self-interest, which may be adverse to our best interest, and they may breach their obligations to us. In addition, we may have limited control over the amount and timing of resources that any future collaborators devote to our or their future products.
Disputes between us and our collaborators may result in litigation or arbitration which would increase our expenses and divert the attention of our management. Further, these transactions and arrangements will be contractual in nature and will generally be terminable under the terms of the applicable agreements and, in such event, we may not continue to have rights to the products relating to such transaction or arrangement or may need to purchase such rights at a premium. If we enter into in-bound intellectual property license agreements, we may not be able to fully protect the licensed intellectual property rights or maintain those licenses. Future licensors could retain the right to prosecute and defend the intellectual property rights licensed to us, in which case we would depend on the ability of our licensors to obtain, maintain and enforce intellectual property protection for the licensed intellectual property. These licensors may determine not to pursue litigation against other companies or may pursue such litigation less aggressively than we would. Further, entering into such license agreements could impose various diligence, commercialization, royalty or other obligations on us. Future licensors may allege that we have breached our license agreement with them, and accordingly seek to terminate our license, which could adversely affect our competitive business position and harm our business prospects.
Unfavorable global economic conditions could negatively affect our business, financial condition or results of operations.
Our results of operations could be adversely affected by general conditions in the global economy and in the global financial markets. A severe or prolonged economic downturn, such as the global financial crisis of 2008, could result in a variety of risks to our business, including weakened demand for our solution, and our ability to raise additional capital when needed on acceptable terms, if at all. A weak or declining economy, including due to the impact of the COVID-19 pandemic, could also strain our suppliers, possibly resulting in supply disruption, or cause our customers to delay making payments for our services. Any of the foregoing will negatively affect our business, financial condition and results of operations and we cannot anticipate all of the ways in which the economic climate and financial market conditions could negatively affect our business, financial condition and results of operations.
We may acquire other companies or technologies, which could divert our management’s attention, result in additional dilution to our stockholders and otherwise negatively affect our business, financial condition and results of operations.
We may in the future seek to acquire or invest in businesses, applications or technologies that we believe could complement or expand our current business, enhance our technical capabilities or otherwise offer growth opportunities. Accordingly, although we have no current commitments with respect to any acquisition or investment, we may in the future pursue the acquisition of, or joint ventures relating to, complementary businesses, applications or technologies instead of developing them ourselves. The pursuit of potential acquisitions may divert the attention of management and cause us to incur various costs and expenses in identifying, investigating and pursuing suitable acquisitions, whether or not they are consummated. We may not be able to identify desirable acquisition targets or be successful in entering into an agreement with any particular target or obtain the expected benefits of any acquisition or investment.
76
We may not be able to successfully integrate acquired personnel, operations and technologies, or effectively manage the combined business following an acquisition. Acquisitions could also result in dilutive issuances of equity securities, the use of our available cash, or the incurrence of debt, which will harm our operating results. In addition, if an acquired business fails to meet our expectations, it will negatively affect our business, financial condition and results of operations.
Consolidation in the healthcare industry or group purchasing organizations could lead to demands for price concessions, which may affect our ability to sell our products at prices necessary to support our current business strategies.
The commercial payor industry is undergoing significant consolidation. When payors combine their operations, the combined company may elect to reimburse our products at the lowest rate paid by any of the participants in the consolidation or use its increased size to negotiate reduced rates. If one of the payors participating in the consolidation does not reimburse for the Zephyr Valve and our solution at all, the combined company may elect not to reimburse for the same, which would adversely impact our operating results.
Our long-term growth depends on our ability to enhance our solution, expand our indications and develop and commercialize additional products. If we fail to identify, acquire and develop other products, we may be unable to grow our business.
It is important to our business that we continue to enhance the Zephyr Valve, Chartis System and StratX Platform and develop and introduce new products. Developing products is expensive and time-consuming and could divert management’s attention away from our core business. The success of any new product offering or product enhancements to our solution will depend on several factors, including our ability to:
•assemble sufficient resources to acquire or discover additional products;
•properly identify and anticipate physician and patient needs;
•develop and introduce new products and product enhancements in a timely manner;
•avoid infringing upon the intellectual property rights of third parties;
•demonstrate, if required, the safety and efficacy of new products with data from pre-clinical studies and clinical trials;
•obtain the necessary regulatory clearances or approvals for expanded indications, new products or product modifications;
•be fully FDA-compliant with marketing of new devices or modified products;
•produce new products in commercial quantities at an acceptable cost;
•provide adequate training to potential users of our products;
•receive adequate coverage and reimbursement for procedures performed with our products; and
•develop an effective and dedicated sales and marketing team.
If we are not successful in expanding our indications and developing and commercializing new products and product enhancements, our ability to increase our revenue may be impaired, which could have a material adverse effect on our business, financial condition and results of operations.
77
In addition, we may choose to focus our efforts and resources on a potential products or indication that ultimately prove to be unsuccessful, or to license or purchase a marketed product that does not meet our financial expectations. As a result, we may fail to capitalize on viable commercial products or profitable market opportunities, be required to forego or delay pursuit of opportunities with other potential products or other diseases that may later prove to have greater commercial potential, or relinquish valuable rights to such potential products through collaboration, licensing or other royalty arrangements in cases in which it would have been advantageous for us to retain sole development and commercialization rights, which could adversely impact our business, financial condition and results of operations.
We may expend our limited resources to pursue a particular product candidate or indication and fail to capitalize on product candidates or indications that may be more profitable or for which there is a greater likelihood of success.
Because we have limited financial and managerial resources, we focus on research programs and products and product candidates that we identify for specific indications. As a result, we may forego or delay pursuit of opportunities with other products or product candidates or for other indications that later prove to have greater commercial potential. Our resource allocation decisions may cause us to fail to timely capitalize on viable commercial products or profitable market opportunities. Our spending on current and future research and development programs and products and product candidates for specific indications may not yield any commercially viable products. If we do not accurately evaluate the commercial potential or target market for a particular product or product candidate, we may relinquish valuable rights to that product or product candidate through collaboration, licensing or other royalty arrangements in cases in which it would have been more advantageous for us to retain sole development and commercialization rights to such product candidate.
We are subject to anti-bribery, anti-corruption, and anti-money laundering laws, including the U.S. Foreign Corrupt Practices Act, as well as export control laws, customs laws, sanctions laws and other laws governing our operations. If we fail to comply with these laws, we could be subject to civil or criminal penalties, other remedial measures and legal expenses, which could negatively affect our business, financial condition and results of operations.
As we grow our international presence and global operations, we will be increasingly exposed to trade and economic sanctions and other restrictions imposed by the United States, the European Union and other governments and organizations. The U.S. Departments of Justice, Commerce, State and Treasury and other federal agencies and authorities have a broad range of civil and criminal penalties they may seek to impose against corporations and individuals for violations of economic sanctions laws, export control laws, the U.S. Foreign Corrupt Practices Act (FCPA), and other federal statutes and regulations, including those established by the Office of Foreign Assets Control (OFAC). In addition, the U.K. Bribery Act of 2010 (Bribery Act) prohibits both domestic and international bribery, as well as bribery across both private and public sectors. An organization that fails to prevent bribery by anyone associated with the organization can be charged under the Bribery Act unless the organization can establish the defense of having implemented adequate procedures to prevent bribery. Under these laws and regulations, as well as other anti-corruption laws, anti-money laundering laws, export control laws, customs laws, sanctions laws and other laws governing our operations, various government agencies may require export licenses, may seek to impose modifications to business practices, including cessation of business activities in sanctioned countries or with sanctioned persons or entities and modifications to compliance programs, which may increase compliance costs, and may subject us to fines, penalties and other sanctions. A violation of these laws or regulations would negatively affect our business, financial condition and results of operations.
We are in the process of enhancing policies and procedures designed to ensure compliance by us and our directors, officers, employees, representatives, consultants and agents with the FCPA, OFAC restrictions, the Bribery Act and other export control, anti-corruption, anti-money-laundering and anti-terrorism laws and regulations. We cannot assure you, however, that our policies and procedures are or will be sufficient or that directors, officers, employees, representatives, consultants and agents have not engaged and will not engage in conduct for which we may be held responsible, nor can we assure you that our business partners have not engaged and will not engage in conduct that could materially affect their ability to perform their contractual obligations to us or even result in our being held
78
liable for such conduct. Violations of the FCPA, OFAC restrictions, the Bribery Act or other export control, anti-corruption, anti-money laundering and anti-terrorism laws or regulations may result in severe criminal or civil sanctions, and we may be subject to other liabilities, which could negatively affect our business, financial condition and results of operations.
Our results may be impacted by changes in foreign currency exchange rates.
A significant proportion of our sales are outside of the United States, and a majority of those are denominated in foreign currencies, which exposes us to foreign currency risks, including changes in currency exchange rates. We do not currently engage in any hedging transactions. If we are unable to address these risks and challenges effectively, our international operations may not be successful, and our business could be harmed.
Our ability to utilize our net operating loss carryforwards and research and development credit may be limited.
In general, under Sections 382 and 383 of the Internal Revenue Code of 1986, as amended (Code) a corporation that undergoes an ownership change, generally defined as a greater than 50% change by value in its equity ownership over a three-year period, is subject to limitations on its ability to utilize its pre-change net operating losses (NOLs) and its research and development credit carryforwards to offset future taxable income. Our existing NOLs and research and development credit carryforwards may be subject to limitations arising from previous ownership changes, and if we undergo an ownership change, our ability to utilize NOLs and research and development credit carryforwards could be further limited by Sections 382 and 383 of the Code. In addition, our ability to deduct net interest expense may be limited if we have insufficient taxable income for the year during which the interest is incurred, and any carryovers of such disallowed interest would be subject to the limitation rules similar to those applicable to NOLs and other attributes. Future changes in our stock ownership, some of which might be beyond our control, could result in an ownership change under Section 382 of the Code. For these reasons, in the event we experience a change of control, we may not be able to utilize a material portion of the NOLs, research and development credit carryforwards or disallowed interest expense carryovers, even if we attain profitability.
We may not be able to achieve or maintain satisfactory pricing and margins for our products.
Manufacturers of medical devices have a history of price competition, and we can give no assurance that we will be able to achieve satisfactory prices for our solution or maintain prices at the levels we have historically achieved. Any decline in the amount that payers reimburse our customers for the Zephyr Valve and related products could make it difficult for customers to continue using, or to adopt, our solution and could create additional pricing pressure for us. If we are forced to lower the price we charge for our solution, our gross margins will decrease, which will adversely affect our ability to invest in and grow our business. If we are unable to maintain our prices, or if our costs increase and we are unable to offset such increase with an increase in our prices, our margins could erode. We will continue to be subject to significant pricing pressure, which will negatively affect our business, financial condition and results of operations.
Governmental export or import controls could limit our ability to compete in foreign markets and subject us to liability if we violate them.
Our products may be subject to U.S. export controls. Governmental regulation of the import or export of our products, or our failure to obtain any required import or export authorization for our products, when applicable, will harm our international sales and adversely affect our revenue. Compliance with applicable regulatory requirements regarding the export of our products may create delays in the introduction of our products in international markets or, in some cases, prevent the export of our products to some countries altogether. Furthermore, U.S. export control laws and economic sanctions prohibit the shipment of certain products and services to countries, governments and persons targeted by U.S. sanctions. If we fail to comply with export and import regulations and such economic sanctions, we may be fined or other penalties could be imposed, including a denial of certain export privileges. Moreover, any new export or import restrictions, new legislation or shifting approaches in the enforcement or scope of existing regulations, or in the countries, persons or technologies targeted by such regulations, could result in decreased use of our products by, or in our decreased ability to export our products to existing or potential customers
79
with international operations. Any decreased use of our products or limitation on our ability to export or sell access to our products would likely negatively affect our business, financial condition and results of operations.
Risks Related to Government Regulation and Our Industry
Our products and operations are subject to extensive government regulation and oversight both in the United States and abroad. If we fail to obtain and maintain necessary regulatory approvals for the Zephyr Valve and related products, or if approvals for future products and indications are delayed or not issued, it will negatively affect our business, financial condition and results of operations.
The Zephyr Valve is subject to extensive regulation by the FDA in the United States and by our Notified Body in the European Union. Government regulations specific to medical devices are wide ranging and govern, among other things:
•product design, development, manufacture, and release;
•laboratory, pre-clinical and clinical testing, labeling, packaging, storage and distribution;
•product safety and efficacy;
•premarketing clearance or approval;
•service operations;
•record keeping;
•product marketing, promotion and advertising, sales and distribution;
•post-marketing surveillance, including reporting of deaths or serious injuries and recalls and correction and removals;
•post-market approval studies; and
•product import and export.
Before a new medical device or service, or a new intended use for an existing product or service, can be marketed in the United States, a company must first submit and receive either 510(k) clearance or PMA from the FDA, unless an exemption applies. In the 510(k) clearance process, before a device may be marketed, the FDA must determine that a proposed device is substantially equivalent to a legally-marketed predicate device, which includes a device that has been previously cleared through the 510(k) process, a device that was legally marketed prior to May 28, 1976 (pre-amendments device), a device that was originally on the U.S. market pursuant to an approved PMA and later down-classified, or a 510(k)-exempt device. To be substantially equivalent, the proposed device must have the same intended use as the predicate device, and either have the same technological characteristics as the predicate device or have different technological characteristics and not raise different questions of safety or effectiveness than the predicate device. Clinical data are sometimes required to support substantial equivalence.
In the process of obtaining PMA approval, which was required for the Zephyr Valve, the FDA must determine that a proposed device is safe and effective for its intended use based, in part, on extensive data, including, but not limited to, technical, pre-clinical, clinical trial, manufacturing and labeling data. The PMA process is typically required for devices that are deemed to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices.
Either the 510(k) or PMA process can be expensive, lengthy and unpredictable. We may not be able to obtain any necessary clearances or approval or may be unduly delayed in doing so, which will negatively affect our business, financial condition and results of operations. Furthermore, even if we are granted regulatory clearances or approvals,
80
they may include significant limitations on the indicated uses for the product, which may limit the market for the product. Although we have obtained PMA approval to market the Zephyr Valve, our approval can be revoked if safety or efficacy problems develop.
The FDA can delay, limit or deny clearance or approval of a device for many reasons, including:
•our inability to demonstrate to the satisfaction of the FDA or the applicable regulatory entity or notified body that our products are safe or effective for their intended uses;
•the disagreement of the FDA or the applicable foreign regulatory body with the design or implementation of our clinical trials or the interpretation of data from pre-clinical studies or clinical trials;
•serious and unexpected adverse device effects experienced by participants in our clinical trials;
•the data from our pre-clinical studies and clinical trials may be insufficient to support clearance or approval, where required;
•our inability to demonstrate that the clinical and other benefits of the device outweigh the risks;
•the manufacturing process or facilities we use may not meet applicable requirements; and
•the potential for approval policies or regulations of the FDA or applicable foreign regulatory bodies to change significantly in a manner rendering our clinical data or regulatory filings insufficient for clearance or approval.
In order to sell our products in member countries of the European Economic Area (EEA), our products must comply with the essential requirements of the European Union Medical Devices Directive (Council Directive 93/42/EEC) (MDD) and the Active Implantable Medical Devices Directive (Council Directive 90/385/EEC). Compliance with these requirements is a prerequisite to be able to affix the Conformité Européene (CE) mark to our products, without which they cannot be sold or marketed in the EEA. To demonstrate compliance with the essential requirements we must undergo a conformity assessment procedure, which varies according to the type of medical device and its classification. Except for low-risk medical devices (Class I non-sterile, non-measuring devices), where the manufacturer can issue an European Commission Declaration of Conformity based on a self-assessment of the conformity of its products with the essential requirements of the MDD, a conformity assessment procedure requires the intervention by a Notified Body. Depending on the relevant conformity assessment procedure, the Notified Body would typically audit and examine the technical file and the quality system for the manufacture, design and final inspection of our devices. The Notified Body issues a certificate of conformity following successful completion of a conformity assessment procedure conducted in relation to the medical device and its manufacturer and their conformity with the essential requirements. This certificate entitles the manufacturer to affix the CE mark to its medical devices after having prepared and signed a related EC Declaration of Conformity. If we fail to remain in compliance with applicable European laws and directives, we would be unable to continue to affix the CE mark to our products, which would prevent us from selling them within the EEA.
The FDA and state and international authorities have broad enforcement powers. Our failure to comply with applicable regulatory requirements could result in enforcement action by any such agency, which may include any of the following sanctions:
•adverse publicity, warning letters, fines, injunctions, consent decrees and civil penalties;
•repair, replacement, refunds, recall or seizure of our products;
•operating restrictions, partial suspension or total shutdown of production;
81
•denial of our requests for regulatory clearance or premarket approval of new products or services, new intended uses or modifications to existing products or services;
•withdrawal of regulatory clearance or premarket approvals that have already been granted; or
•criminal prosecution.
If any of these events were to occur, it will negatively affect our business, financial condition and results of operations.
Changes in the regulatory environment may constrain or require us to restructure our operations, which may harm our revenue and operating results.
Healthcare laws and regulations change frequently and may change significantly in the future. We may not be able to adapt our operations to address every new regulation, and new regulations may negatively affect our business, financial condition and results of operations. We cannot assure you that a review of our business by courts or regulatory authorities would not result in a determination that adversely affects our revenue and operating results, or that the healthcare regulatory environment will not change in a way that restricts our operations. In addition, there is risk that the U.S. Congress may implement changes in laws and regulations governing healthcare service providers, including measures to control costs, or reductions in reimbursement levels, which may negatively affect our business, financial condition and results of operations.
The federal government is considering ways to change, and has changed, the manner in which healthcare services are paid for in the United States. CMS establishes Medicare payment levels for hospitals and physicians on an annual basis, which can increase or decrease payment to such entities. CMS, as well as insurers, have increased their efforts to control the cost, utilization and delivery of healthcare services. From time to time, the U.S. Congress has considered and implemented changes in the CMS fee schedules in conjunction with budgetary legislation. Further reductions of reimbursement by CMS for services or changes in policy regarding coverage of tests or other services provided or other requirements for payment, such as prior authorization or a physician’s or qualified practitioner’s signature on test/service requisitions, may be implemented from time to time. Individual states may also enact legislation that impacts Medicaid payments to hospitals and physicians. Reductions in the reimbursement rates and changes in payment policies of other third-party payors may occur as well. Similar changes in the past have resulted in reduced payments as well as added costs and have added more complex regulatory and administrative requirements. Further changes in federal, state, local and third-party payor regulations or policies may negatively affect our business, financial condition and results of operations. Actions by agencies regulating insurance or changes in other laws, regulations, or policies may also negatively affect our business, financial condition and results of operations.
On April 5, 2017, the European Parliament passed the Medical Devices Regulation (Regulation 2017/745), which repeals and replaces the MDD and the Active Implantable Medical Devices Directive. Unlike directives, which must be implemented into the national laws of the EEA member states, the regulations would be directly applicable, i.e., without the need for adoption of EEA member state laws implementing them, in all EEA member states and are intended to eliminate current differences in the regulation of medical devices among EEA member States. The Medical Devices Regulation, among other things, is intended to establish a uniform, transparent, predictable and sustainable regulatory framework across the EEA for medical devices and ensure a high level of safety and health while supporting innovation.
The Medical Devices Regulation will become applicable in 2021. Once applicable, the new regulations will among other things:
•strengthen the rules on placing devices on the market and reinforce surveillance once they are available;
•establish explicit provisions on manufacturers’ responsibilities for the follow-up of the quality, performance and safety of devices placed on the market;
82
•improve the traceability of medical devices throughout the supply chain to the end-user or patient through a unique identification number;
•set up a central database to provide patients, healthcare professionals and the public with comprehensive information on products available in the European Union; and
•strengthen rules for the assessment of certain high-risk devices, such as implants, which may have to undergo an additional check by experts before they are placed on the market.
These modifications may have an effect on the way we conduct our business in the EEA.
Changes in funding for, or disruptions caused by global health concerns impacting, the FDA and other government agencies could hinder their ability to hire and retain key leadership and other personnel, or otherwise prevent new products and services from being developed, cleared or approved or commercialized in a timely manner, which could negatively impact our business.
The ability of the FDA to review and approve new products can be affected by a variety of factors, including government budget and funding levels, ability to hire and retain key personnel and accept the payment of user fees, statutory, regulatory, and policy changes and other events that may otherwise affect the FDA’s ability to perform routine functions. Average review times at the agency have fluctuated in recent years as a result. In addition, government funding of other government agencies that fund research and development activities is subject to the political process, which is inherently fluid and unpredictable.
Disruptions at the FDA and other agencies may also slow the time necessary for new devices to be reviewed and/or approved or cleared by necessary government agencies, which would adversely affect our business. For example, over the last several years, including for 35 days beginning on December 22, 2018, the U.S. government has shut down several times and certain regulatory agencies, such as the FDA, have had to furlough critical FDA employees and stop critical activities. Separately, in response to the COVID-19 pandemic, in March 2020, the FDA announced its intention to postpone inspections of foreign manufacturing facilities and products, and routine surveillance inspections of domestic manufacturing facilities. In July 2020, the FDA resumed inspections on a risk-based basis. Other regulatory authorities may adopt similar restrictions or other policy measures in response to the COVID-19 pandemic. If a prolonged government shutdown occurs, or if global health concerns continue to prevent the FDA or other regulatory authorities from conducting business as usual or conducting inspections, reviews or other regulatory activities, it could significantly impact the ability of the FDA to timely review and process our regulatory submissions, which could have a material adverse effect on our business.
A recall of our products, either voluntarily or at the direction of the FDA or another governmental authority, or the discovery of serious safety issues with our products that leads to corrective actions, could have a significant adverse impact on us.
The FDA and similar foreign governmental authorities have the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture of a product or in the event that a product poses an unacceptable risk to health. The FDA’s authority to require a recall must be based on an FDA finding that there is reasonable probability that the device would cause serious injury or death. Manufacturers may also, under their own initiative, recall a product if any material deficiency in a device is found or withdraw a product to improve device performance or for other reasons. The FDA requires that certain classifications of recalls be reported to the FDA within ten working days after the recall is initiated. A government-mandated or voluntary recall by us could occur as a result of an unacceptable risk to health, component failures, malfunctions, manufacturing errors, design or labeling defects or other deficiencies and issues. Similar regulatory agencies in other countries have similar authority to recall devices because of material deficiencies or defects in design or manufacture that could endanger health. Any recall would divert management attention and financial resources and could cause the price of our stock to decline, expose us to product liability or other claims and harm our reputation with customers. A future recall announcement will harm our reputation with customers and negatively affect our sales. In addition, the FDA
83
or a foreign governmental authority could take enforcement action for failing to report the recalls when they were conducted.
In addition, under the FDA’s medical device reporting regulations (MDRs), we are required to report to the FDA any incident in which our product may have caused or contributed to a death or serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury. Repeated product malfunctions may result in a voluntary or involuntary product recall. We are also required to follow detailed recordkeeping requirements for all firm-initiated medical device corrections and removals, and to report such corrective and removal actions to FDA if they are carried out in response to a risk to health and have not otherwise been reported under the MDRs. Depending on the corrective action we take to redress a product’s deficiencies or defects, the FDA may require, or we may decide, that we will need to obtain new approvals or clearances for the device before we may market or distribute the corrected device. Seeking such approvals or clearances may delay our ability to replace the recalled devices in a timely manner. Moreover, if we do not adequately address problems associated with our devices, we may face additional regulatory enforcement action, including FDA warning letters, product seizure, injunctions, administrative penalties, or civil or criminal fines. We may also be required to bear other costs or take other actions that may have a negative impact on our sales as well as face significant adverse publicity or regulatory consequences, which will negatively affect our business, financial condition and results of operations, including our ability to market our products in the future.
Any adverse event involving our products, whether in the United States or abroad, could result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection, mandatory recall or other enforcement action. Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business and may harm our reputation and financial results.
We are subject to certain federal, state and foreign fraud and abuse laws, health information privacy and security laws and transparency laws, which, if violated, could subject us to substantial penalties and negatively affect our business, financial condition and results of operations.
The products and services we offer are highly regulated, and there can be no assurance that the regulatory environment in which we operate will not change significantly and adversely in the future. Our arrangements with physicians, hospitals and clinics may expose us to broadly applicable fraud and abuse and other laws and regulations that may restrict the financial arrangements and relationships through which we market, sell and distribute our products and services. Federal and state healthcare laws and regulations that may affect our ability to conduct business, include, without limitation:
•federal and state laws and regulations regarding billing and claims payment applicable to our solution and regulatory agencies enforcing those laws and regulations;
•the federal Anti-Kickback Statute, which prohibits, among other things, any person from knowingly and willfully offering, soliciting, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual for, or the purchase, order or recommendation of, any good or service for which payment may be made under federal healthcare programs, such as Medicare and Medicaid;
•the federal false claims laws, including the False Claims Act, which prohibit, among other things, individuals or entities from knowingly presenting, or causing to be presented, false claims, or knowingly using false statements, to obtain payment from the federal government;
•federal criminal laws that prohibit executing a scheme to defraud any healthcare benefit program or making false statements relating to healthcare matters;
•the federal Physician Payments Sunshine Act (Open Payments), created under the Patient Affordable Care Act, as amended by the Health Care and Education Reconciliation Act of 2010 (collectively, the Affordable
84
Care Act) and its implementing regulations, which requires certain manufacturers of drugs, medical devices, biologicals and medical supplies for which payment is available under Medicare, Medicaid, or the Children’s Health Insurance Program to report annually to CMS, information related to payments or other transfers of value made to physicians (defined to include doctors, dentists, optometrists, podiatrists and chiropractors) and teaching hospitals, as well as ownership and investment interests held by physicians and their immediate family members. Beginning in 2022, applicable manufacturers also will be required to report information regarding payments and other transfers of value provided during the previous year to physician assistants, nurse practitioners, clinical nurse specialists, anesthesiologist assistants, certified registered nurse anesthetists and certified nurse midwives;
•federal consumer protection and unfair competition laws, which broadly regulate marketplace activities and activities that potentially harm consumers;
•the Health Insurance Portability and Accountability Act of 1996 (HIPAA), as amended by the Health Information Technology for Economic and Clinical Health Act (HITECH), and its implementing regulations, which impose certain requirements relating to the privacy, security and transmission of individually identifiable health information on covered entities, including certain healthcare providers, health plans and healthcare clearinghouses, and their respective business associates that create, receive, maintain or transmit individually identifiable health information for or on behalf of a covered entity as well as their covered subcontractors; HIPAA also created criminal liability for, among other things, knowingly and willfully falsifying or concealing a material fact or making a materially false statement in connection with the delivery of or payment for healthcare benefits, items or services;
•the Federal Drug & Cosmetic Act (FDCA), which prohibits, among other things, the adulteration or misbranding of drugs, biologics and medical devices;
•the federal physician self-referral prohibition, commonly known as the Stark Law , which prohibits, among other things, physicians who have a financial relationship, including an investment, ownership or compensation relationship with an entity, from referring Medicare and Medicaid patients to that entity for designated health services, which include clinical laboratory services, unless an exception applies. Similarly, entities may not bill Medicare, Medicaid or any other party for services furnished pursuant to a prohibited referral;
•state law equivalents of each of the above federal laws, such as anti-kickback and false claims laws which may apply to items or services reimbursed by any third-party payor, including commercial insurers, and state and foreign laws governing the privacy and security of health information in certain circumstances, many of which differ from each other in significant ways and often are not preempted by HIPAA, thus complicating compliance efforts; and
•similar healthcare laws and regulations in the European Union and other jurisdictions, including reporting requirements detailing interactions with and payments to healthcare providers and laws governing the privacy and security of certain protected information, such as the General Data Protection Regulation (GDPR), which imposes obligations and restrictions on the collection and use of personal data relating to individuals located in the European Union (including health data).
The Affordable Care Act was enacted in 2010. The Affordable Care Act, among other things, amended the intent requirement of the federal Anti-Kickback Statute and criminal healthcare fraud statutes, including those created under HIPAA. A person or entity no longer needs to have actual knowledge of this statute or specific intent to violate it. In addition, the Affordable Care Act provides that the government may assert that a claim including items or services resulting from a violation of the federal Anti-Kickback Statute constitutes a false or fraudulent claim for purposes of the False Claims Act.
85
To enforce compliance with the healthcare regulatory laws, certain enforcement bodies have continued their scrutiny of interactions between healthcare companies and healthcare providers, which has led to a number of investigations, prosecutions, convictions and settlements in the healthcare industry. Responding to investigations can be time and resource-consuming and can divert management’s attention from the business. Additionally, as a result of these investigations, healthcare providers and entities may have to agree to additional compliance and reporting requirements as part of a consent decree or corporate integrity agreement. Any such investigation or settlement could increase our costs or otherwise negatively affect our business, financial condition and results of operations. Even an unsuccessful challenge or investigation into our practices could cause adverse publicity and be costly to respond to.
Although we have adopted policies and procedures designed to comply with these laws and regulations and conduct internal reviews of our compliance with these laws, our activities, including those relating to the reporting of discount and rebate information and other information affecting federal, state and third-party reimbursement of our products (such as our patient reimbursement support program) and the sale and marketing of our products, may be subject to scrutiny by under these laws. Because of the breadth of these laws and the narrowness of available statutory exceptions and regulatory safe harbors, it is possible that some of our activities could be subject to challenge under one or more such laws. The growth of our business and sales organization and our expansion outside of the United States may increase the potential of violating these laws or our internal policies and procedures. Any action brought against us for violation of these or other laws or regulations, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. If our operations are found to be in violation of any of the federal, state and foreign laws described above or any other current or future fraud and abuse or other healthcare laws and regulations that apply to us, we may be subject to significant penalties, including significant criminal, civil, and administrative penalties, damages, fines, imprisonment for individuals, additional oversight and reporting obligations, exclusion from participation in government programs, such as Medicare and Medicaid, imprisonment, contractual damages, reputation harm and disgorgement and we could be required to curtail or cease our operations. Any of the foregoing consequences will negatively affect our business, financial condition and results of operations.
If we modify the Zephyr Valve, we may need to seek additional clearances or approvals, which, if not granted, would prevent us from selling our modified products.
In the United States, the Zephyr Valve is marketed pursuant to a PMA order issued by the FDA. Any modifications to a PMA-approved device that could significantly affect its safety or effectiveness, including significant design and manufacturing changes, or that would constitute a major change in its intended use, manufacture, design, components, or technology requires approval of a new PMA application or PMA supplement. However, certain changes to a PMA-approved device do not require submission and approval of a new PMA or PMA supplement and may only require notice to FDA in a PMA 30-Day Notice, Special PMA Supplement - Changes Being Effected or PMA Annual Report. The FDA requires every manufacturer to make this determination in the first instance, but the FDA may review any manufacturer’s decision. The FDA may not agree with our decisions regarding whether new approvals are necessary. If the FDA disagrees with our determination and requires us to seek new PMA approvals for modifications to our previously approved products for which we have concluded that new approvals are unnecessary, we may be required to cease marketing or to recall the modified product until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties. Furthermore, our products could be subject to recall if the FDA determines, for any reason, that our products are not safe or effective or that appropriate regulatory submissions were not made. Delays in receipt or failure to receive approvals, the loss of previously received approvals, or the failure to comply with any other existing or future regulatory requirements, could reduce our sales, profitability and future growth prospects.
Failure to comply with post-marketing regulatory requirements could subject us to enforcement actions, including substantial penalties, and might require us to recall or withdraw a product from the market.
Even though we have obtained approval for the Zephyr Valve, we are subject to ongoing and pervasive regulatory requirements governing, among other things, the manufacture, marketing, advertising, medical device reporting, sale, promotion, registration, and listing of devices. For example, we must submit periodic reports to the FDA as a
86
condition of PMA approval. These reports include safety and effectiveness information about the device after its approval. Failure to submit such reports, or failure to submit the reports in a timely manner, could result in enforcement action by the FDA. Following its review of the periodic reports, the FDA might ask for additional information or initiate further investigation.
In addition, the PMA approval for the Zephyr Valve was subject to several conditions of approval, including extended follow-up of the pre-market study cohort and post market study. Though we believe we have complied with these conditions to date, any failure to comply with the conditions of approval could result in the withdrawal of PMA approval and the inability to continue to market the device. Failure to conduct the required studies in accordance with Institutional Review Board (IRB) and informed consent requirements, or adverse findings in these studies, could also be grounds for withdrawal of approval of the PMA.
The regulations to which we are subject are complex and have become more stringent over time. Regulatory changes could result in restrictions on our ability to continue or expand our operations, higher than anticipated costs, or lower than anticipated sales. Even after we have obtained the proper regulatory approval to market a device, we have ongoing responsibilities under FDA regulations and applicable foreign laws and regulations. Our failure to comply with applicable regulatory requirements could result in enforcement action by the FDA, state or foreign regulatory authorities, which will negatively affect our business, financial condition and results of operations.
If treatment guidelines for severe emphysema or the standard of care evolves, we may need to redesign and seek new marketing authorization from the FDA for one or more of our products.
If treatment guidelines for severe emphysema changes or the standard of care for this condition evolves, we may need to redesign the applicable product and seek new approvals from the FDA. Our PMA approvals from the FDA are based on current treatment guidelines. If treatment guidelines change so that different treatments become desirable, the clinical utility of one or more of our products could be diminished and will negatively affect our business, financial condition and results of operations.
If we or our suppliers fail to comply with the FDA’s QSR or the European Union Medical Devices Directive, our manufacturing or distribution operations could be delayed or shut down and our revenue could suffer.
Our manufacturing and design processes and those of our third-party suppliers are required to comply with the FDA’s QSR and the European Union Medical Devices Directive (Council Directive 93/42/EEC) (MDD), both of which cover procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, storage and shipping of Zephyr Valves. We are also subject to similar state requirements and licenses, and to ongoing International Organization for Standardization (ISO) compliance in all operations, including design, manufacturing, and service, to maintain our CE Mark. In addition, we must engage in extensive recordkeeping and reporting and must make available our facilities and records for periodic unannounced inspections by governmental agencies, including the FDA, state authorities, European Union Notified Bodies and comparable agencies in other countries. If we fail a regulatory inspection, our operations could be disrupted and our manufacturing interrupted. Failure to take adequate corrective action in response to an adverse regulatory inspection could result in, among other things, a shutdown of our manufacturing or product distribution operations, significant fines, suspension of marketing clearances and approvals, seizures or recalls of our device, operating restrictions and criminal prosecutions, any of which would negatively affect our business, financial condition and results of operations. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with applicable regulatory requirements, which may result in manufacturing delays for our product and cause our revenue to decline.
We are registered with the FDA as a manufacturer. The FDA has broad post-market and regulatory enforcement powers. We are subject to unannounced inspections by the FDA and the Food and Drug Branch of the California Department of Public Health (CDPH) to determine our compliance with the QSR and other regulations at our manufacturing facility, and these inspections may include the manufacturing facilities of our suppliers. Our design facilities in Redwood City, California were most recently audited by the FDA in November 2016 and no
87
observations resulting in a warning letter were identified. We believe that we are in compliance, in all material respects, with the QSR.
We also maintain a certificate of registration for the design, manufacture, service, and distribution of our product from British Standards Institution (BSI) in the Netherlands, our European Notified Body. Most recently, BSI completed an ISO 13485 surveillance audit of our design, manufacturing and service operations in April 2020 and we believe that we are in compliance, in all material respects, with the MDD.
We can provide no assurance that we will continue to remain in compliance with the QSR or MDD. If the FDA, CDPH or BSI inspect any of our facilities and discover compliance problems, we may have to cease manufacturing and product distribution until we can take the appropriate remedial steps to correct the audit findings. Taking corrective action may be expensive, time consuming and a distraction for management and if we experience a delay at our manufacturing facility, we may be unable to produce our solutions, which will negatively affect our business, financial condition and results of operations.
The misuse or off-label use of our solution will harm our image in the marketplace, result in injuries that lead to product liability suits or result in costly investigations and sanctions by regulatory bodies if we are deemed to have engaged in the promotion of these uses, any of which will negatively affect our business, financial condition and results of operations.
Our solution has been approved by the FDA for specific indications. We train our marketing and direct sales force to not promote our products for uses outside of the FDA-approved indications for use, known as “off-label” uses. We cannot, however, prevent a physician from using our products off-label, when in the physician’s independent professional medical judgment, he or she deems it appropriate. There may be increased risk of injury to patients if physicians attempt to use our products off-label. Furthermore, the use of our products for indications other than those approved by the FDA or any foreign regulatory body may not effectively treat such conditions, which will harm our reputation in the marketplace among physicians and patients.
Physicians may also misuse our products or use improper techniques if they are not adequately trained, potentially leading to injury and an increased risk of product liability. If our products are misused or used with improper technique, we may become subject to costly litigation by our customers or their patients. Product liability claims could divert management’s attention from our core business, be expensive to defend, and result in sizable damage awards against us that may not be covered by insurance. In addition, if the FDA or any foreign regulatory body determines that our promotional materials or training constitute promotion of an off-label use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine or criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our business activities to constitute promotion of an off-label use, which could result in significant penalties, including, but not limited to, criminal, civil and administrative penalties, damages, fines, disgorgement, exclusion from participation in government healthcare programs, and the curtailment of our operations. Any of these events will negatively affect our business, financial condition and results of operations and cause our stock price to decline.
We may be subject to regulatory or enforcement actions if we engage in improper marketing or promotion of our products.
Our educational and promotional activities and training methods must comply with FDA and other applicable laws, including the prohibition of the promotion of a medical device for a use that has not been cleared or approved by the FDA. Use of a device outside of its cleared or approved indications is known as “off-label” use. Physicians may use our products off-label in their professional medical judgment, as the FDA does not restrict or regulate a physician’s choice of treatment within the practice of medicine. However, if the FDA determines that our educational and promotional activities or training constitutes promotion of an off-label use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of warning letters, untitled letters, fines, penalties, injunctions, or seizures, which could have an adverse impact on our reputation and financial results. It is also possible that other federal, state or foreign enforcement authorities might
88
take action if they consider our educational and promotional activities or training methods to constitute promotion of an off-label use, which could result in significant fines or penalties under other statutory authorities, such as laws prohibiting false claims for reimbursement. In that event, our reputation could be damaged, and adoption of the products could be impaired. Although our policy is to refrain from statements that could be considered off-label promotion of our products, the FDA or another regulatory agency could disagree and conclude that we have engaged in off-label promotion. It is also possible that other federal, state or foreign enforcement authorities might take action, such as federal prosecution under the federal civil False Claims Act, if they consider our business activities constitute promotion of an off-label use, which could result in significant penalties, including, but not limited to, criminal, civil or administrative penalties, damages, fines, disgorgement, exclusion from participation in government healthcare programs, additional reporting requirements and oversight if we become subject to a corporate integrity agreement or similar agreement to resolve allegations of non-compliance with these laws, and the curtailment or restructuring of our operations. In addition, the off-label use of our products may increase the risk of product liability claims. Product liability claims are expensive to defend and could divert our management’s attention, result in substantial damage awards against us, and harm our reputation.
The clinical trial process required to obtain regulatory approvals is lengthy and expensive with uncertain outcomes. If clinical studies of our future products do not produce results necessary to support regulatory clearance or approval in the United States or, with respect to our current or future products, elsewhere, we will be unable to expand the indications for or commercialize these products and may incur additional costs or experience delays in completing, or ultimately be unable to complete, the commercialization of those products.
We have obtained PMA approval for the Zephyr Valve. In order to obtain PMA approval for a device, the sponsor must conduct well-controlled clinical trials designed to assess the safety and efficacy of the product candidate. Conducting clinical trials is a complex and expensive process, can take many years, and outcomes are inherently uncertain. We incur substantial expense for, and devote significant time to, clinical trials but cannot be certain that the trials will ever result in commercial revenue. We may experience significant setbacks in clinical trials, even after earlier clinical trials showed promising results, and failure can occur at any time during the clinical trial process. Any of our products may malfunction or may produce undesirable adverse effects that could cause us or regulatory authorities to interrupt, delay or halt clinical trials. We, the FDA, or another regulatory authority may suspend or terminate clinical trials at any time to avoid exposing trial participants to unacceptable health risks.
Successful results of pre-clinical studies are not necessarily indicative of future clinical trial results, and predecessor clinical trial results may not be replicated in subsequent clinical trials. Additionally, the FDA may disagree with our interpretation of the data from our pre-clinical studies and clinical trials, or may find the clinical trial design, conduct or results inadequate to prove safety or efficacy, and may require us to pursue additional pre-clinical studies or clinical trials, which could further delay the clearance or approval of our products. The data we collect from our pre-clinical studies and clinical trials may not be sufficient to support FDA clearance or approval, and if we are unable to demonstrate the safety and efficacy of our future products in our clinical trials, we will be unable to obtain regulatory clearance or approval to market our products.
In addition, we may estimate and publicly announce the anticipated timing of the accomplishment of various clinical, regulatory and other product development goals, which are often referred to as milestones. These milestones could include the obtainment of the right to affix the CE mark in the European Union; the submission to the FDA of an Investigational Device Exemption (IDE) application to commence a pivotal clinical trial for a new product candidate; the enrollment of patients in clinical trials; the release of data from clinical trials; and other clinical and regulatory events. The actual timing of these milestones could vary dramatically compared to our estimates, in some cases for reasons beyond our control. We cannot assure you that we will meet our projected milestones and if we do not meet these milestones as publicly announced, the commercialization of our products may be delayed and, as a result, our stock price may decline.
Clinical trials are necessary to support PMA applications and may be necessary to support PMA supplements for modified versions of our marketed device products. This would require the enrollment of large numbers of suitable subjects, which may be difficult to identify, recruit and maintain as participants in the clinical trial. Adverse outcomes in the post-approval studies could also result in restrictions or withdrawal of approval of the PMA. We
89
will likely need to conduct additional clinical studies in the future to support new indications for our products or for approvals or clearances of new product lines, or for the approval of the use of our products in some foreign countries. Clinical testing is difficult to design and implement, can take many years, can be expensive and carries uncertain outcomes. The initiation and completion of any of these studies may be prevented, delayed, or halted for numerous reasons. We may experience a number of events that could adversely affect the costs, timing or successful completion of our clinical trials, including:
•we may be required to submit an IDE application to the FDA, which must become effective prior to commencing human clinical trials, and the FDA may reject our IDE application and notify us that we may not begin investigational trials;
•regulators and other comparable foreign regulatory authorities may disagree as to the design or implementation of our clinical trials;
•regulators, IRBs or other reviewing bodies may not authorize us or our investigators to commence a clinical trial, or to conduct or continue a clinical trial at a prospective or specific trial site;
•we may not reach agreement on acceptable terms with prospective contract research organizations (CROs) and clinical trial sites, the terms of which can be subject to extensive negotiation and may vary significantly among different CROs and trial sites;
•clinical trials may produce negative or inconclusive results, and we may decide, or regulators may require us, to conduct additional clinical trials or abandon product development programs;
•the number of subjects or patients required for clinical trials may be larger than we anticipate, enrollment in these clinical trials may be insufficient or slower than we anticipate, and the number of clinical trials being conducted at any given time may be high and result in fewer available patients for any given clinical trial, or patients may drop out of these clinical trials at a higher rate than we anticipate;
•our third-party contractors, including those manufacturing products or conducting clinical trials on our behalf, may fail to comply with regulatory requirements or meet their contractual obligations to us in a timely manner, or at all;
•we might have to suspend or terminate clinical trials for various reasons, including a finding that the subjects are being exposed to unacceptable health risks;
•we may have to amend clinical trial protocols or conduct additional studies to reflect changes in regulatory requirements or guidance, which we may be required to submit to an IRB or regulatory authority for re-examination;
•regulators, IRBs, or other parties may require or recommend that we or our investigators suspend or terminate clinical research for various reasons, including safety signals or noncompliance with regulatory requirements;
•the cost of clinical trials may be greater than we anticipate;
•clinical sites may not adhere to the clinical protocol or may drop out of a clinical trial;
•we may be unable to recruit a sufficient number of clinical trial sites;
•regulators, IRBs, or other reviewing bodies may fail to approve or subsequently find fault with our manufacturing processes or facilities of third-party supplier with which we enter into agreement for clinical and commercial supplies, the supply of devices or other materials necessary to conduct clinical trials may
90
be insufficient, inadequate or not available at an acceptable cost, or we may experience interruptions in supply;
•approval policies or regulations of the FDA or applicable foreign regulatory agencies may change in a manner rendering our clinical data insufficient for approval; and
•our current or future products may have undesirable side effects or other unexpected characteristics.
Patient enrollment in clinical trials and completion of patient follow-up depend on many factors, including the size of the patient population, the nature of the trial protocol, the proximity of patients to clinical sites, the eligibility criteria for the clinical trial, patient compliance, competing clinical trials and clinicians’ and patients’ perceptions as to the potential advantages of the product being studied in relation to other available therapies, including any new treatments that may be approved for the indications we are investigating. For example, patients may be discouraged from enrolling in our clinical trials if the trial protocol requires them to undergo extensive post-treatment procedures or follow-up to assess the safety and efficacy of a product candidate, or they may be persuaded to participate in contemporaneous clinical trials of a competitor’s product candidate or provider’s competing clinical trial. In addition, patients participating in our clinical trials may drop out before completion of the trial or experience adverse medical events unrelated to our products. Delays in patient enrollment or failure of patients to continue to participate in a clinical trial may delay commencement or completion of the clinical trial, cause an increase in the costs of the clinical trial and delays, or result in the failure of the clinical trial.
Clinical trials must be conducted in accordance with the laws and regulations of the FDA and other applicable regulatory authorities’ legal requirements, regulations or guidelines, and are subject to oversight by these governmental agencies and IRBs at the medical institutions where the clinical trials are conducted. In addition, clinical trials must be conducted with supplies of our devices produced under current good manufacturing practice, or Current Good Manufacturing Practices, requirements and other regulations. Furthermore, we may rely on CROs, and clinical trial sites to ensure the proper and timely conduct of our clinical trials and we may have limited influence over their actual performance. We depend on our collaborators and on medical institutions and CROs to conduct our clinical trials in compliance with good clinical practice, or GCP, requirements. To the extent our collaborators or the CROs fail to enroll participants for our clinical trials, fail to conduct the study to GCP standards or are delayed for a significant time in the execution of trials, including achieving full enrollment, we may be affected by increased costs, program delays or both. In addition, clinical trials that are conducted in countries outside the United States may subject us to further delays and expenses as a result of increased shipment costs, additional regulatory requirements and the engagement of non-U.S. CROs, as well as expose us to risks associated with clinical investigators who are unknown to the FDA, and different standards of diagnosis, screening and medical care.
Even if our future products are cleared or approved in the United States, commercialization of our products in foreign countries would require clearance or approval by regulatory authorities in those countries. Clearance or approval procedures vary among jurisdictions and can involve requirements and administrative review periods different from, and greater than, those in the United States, including additional preclinical studies or clinical trials. Any of these occurrences could have an adverse effect on our business, financial condition and results of operations.
Our products may cause or contribute to adverse medical events or be subject to failures or malfunctions that we are required to report to the FDA, and if we fail to do so, we would be subject to sanctions that could negatively affect our business, financial condition and results of operations.
We are required to file various reports with the FDA and European regulators, including reports required by the MDRs that require that we report to the regulatory authorities if our solutions may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur and we have filed such reports in the past. The timing of our obligation to report is triggered by the date we become aware of the adverse event as well as the nature of the event. We may fail to report adverse events of which we become aware within the prescribed timeframe. We may also fail to recognize that we have become aware of a reportable adverse event, especially if it is not reported to us as an adverse event or if it is an adverse event that is unexpected or removed in time from the use of the product. If these reports are not filed in a
91
timely manner, regulators may impose sanctions and we may be subject to product liability or regulatory enforcement actions, all of which will negatively affect our business, financial condition and results of operations.
If we initiate a correction or removal for the Zephyr Valve to reduce a risk to health posed by it, we would be required to submit a publicly available correction and removal report to the FDA and, in many cases, similar reports to other regulatory agencies. This report could be classified by the FDA as a device recall which could lead to increased scrutiny by the FDA, other international regulatory agencies and our customers regarding the quality and safety of our solutions. Furthermore, the submission of these reports could be used by competitors against us and cause physicians to delay or cancel prescriptions, which will harm our reputation.
If we assess a potential quality issue or complaint as not requiring either field action or notification, respectively, regulators may review documentation of that decision during a subsequent audit. If regulators disagree with our decision, or take issue with either our investigation process or the resulting documentation, regulatory agencies may impose sanctions and we may be subject to regulatory enforcement actions, including warning letters, all of which will negatively affect our business, financial condition and results of operations.
If we do not obtain and maintain international regulatory registrations or approvals for our products, we will be unable to market and sell our products outside of the United States.
Sales of our products outside of the United States are subject to foreign regulatory requirements that vary widely from country to country. In addition, the FDA regulates exports of medical devices from the United States. While the regulations of some countries may not impose barriers to marketing and selling our products or only require notification, others require that we obtain the approval of a specified regulatory body. Complying with foreign regulatory requirements, including obtaining registrations or approvals, can be expensive and time-consuming, and we may not receive regulatory approvals in each country in which we plan to market our products, or we may be unable to do so on a timely basis. The time required to obtain registrations or approvals, if required by other countries, may be longer than that required for FDA approval, and requirements for such registrations, clearances or approvals may significantly differ from FDA requirements. If we modify our products, we may need to apply for additional regulatory approvals before we are permitted to sell the modified product. In addition, we may not continue to meet the quality and safety standards required to maintain the authorizations that we have received. If we are unable to maintain our authorizations in a particular country, we will no longer be able to sell the applicable product in that country.
Regulatory approval by the FDA does not ensure registration, clearance or approval by regulatory authorities in other countries, and registration, clearance or approval by one or more foreign regulatory authorities does not ensure registration, clearance or approval by regulatory authorities in other foreign countries or by the FDA. However, a failure or delay in obtaining registration or regulatory clearance or approval in one country may have a negative effect on the regulatory process in others.
Healthcare reform measures could hinder or prevent the commercial success of our solutions.
In the United States, there have been, and we expect there will continue to be, a number of legislative and regulatory changes to the healthcare system in ways that will harm our future revenues and profitability and the demand for our solutions. Federal and state lawmakers regularly propose and, at times, enact legislation that would result in significant changes to the healthcare system, some of which are intended to contain or reduce the costs of medical products and services. Current and future legislative proposals to further reform healthcare or reduce healthcare costs may limit coverage of or lower reimbursement for the procedures associated with the use of our products. The cost containment measures that payers and providers are instituting and the effect of any healthcare reform initiative implemented in the future could impact our revenue from the sale of our products. For example, the Affordable Care Act contains a number of provisions, including those governing enrollment in federal healthcare programs, reimbursement changes and fraud and abuse measures, all of which will impact existing government healthcare programs and will result in the development of new programs. The Affordable Care Act, among other things, imposed an excise tax of 2.3% on the sale of most medical devices, including ours, and any failure to pay this
92
amount could result in the imposition of an injunction on the sale of our products, fines and penalties. However, the 2020 federal spending package permanently eliminated this medical device excise tax effective January 1, 2020.
There have been executive, judicial and Congressional challenges to certain aspects of the Affordable Care Act. For example, President Trump signed several Executive Orders and other directives designed to delay the implementation of certain provisions of the Affordable Care Act. Concurrently, Congress considered legislation to repeal or repeal and replace all or part of the Affordable Care Act. While Congress has not passed comprehensive repeal legislation, it has enacted laws that modify certain provisions of the Affordable Care Act such as removing penalties, starting January 1, 2019, for not complying with the Affordable Care Act’s individual mandate to carry health insurance and delaying the implementation of certain fees mandated by the Affordable Care Act. On December 14, 2018, a Texas U.S. District Court Judge ruled that the Affordable Care Act is unconstitutional in its entirety because the individual mandate was repealed by Congress as part of the Tax Cuts and Jobs Act of 2017. Additionally, on December 18, 2019, the U.S. Court of Appeals for the 5th Circuit upheld the District Court ruling that the individual mandate was unconstitutional and remanded the case back to the District Court to determine whether the remaining provisions of the Affordable Care Act are invalid as well. The United States Supreme Court is currently reviewing this case, but it is unknown when a decision will be reached. Although the Supreme Court has not yet ruled on the constitutionality of the Affordable Care Act, on January 28, 2021, President Biden issued an executive order to initiate a special enrollment period from February 15, 2021 through May 15, 2021 for purposes of obtaining health insurance coverage through the Affordable Care Act marketplace. The executive order also instructs certain governmental agencies to review and reconsider their existing policies and rules that limit access to healthcare, including among others, reexamining Medicaid demonstration projects and waiver programs that include work requirements, and policies that create unnecessary barriers to obtaining access to health insurance coverage through Medicaid or the Affordable Care Act. It is unclear how the Supreme Court ruling, other such litigation and the healthcare reform measures of the Biden administration will impact the Affordable Care Act and negatively affect our business, financial condition and results of operations.
In addition, other legislative changes have been proposed and adopted since the Affordable Care Act was enacted. For example, the Budget Control Act of 2011, among other things, included reductions to CMS payments to providers of 2% per fiscal year, which went into effect on April 1, 2013 and, due to subsequent legislative amendments to the statute, will remain in effect through 2030 unless additional Congressional action is taken. However, COVID-19 relief legislation suspended the 2% Medicare sequester from May 1, 2020 through March 31, 2021. Additionally, the American Taxpayer Relief Act of 2012, among other things, reduced CMS payments to several providers, including hospitals, and increased the statute of limitations period for the government to recover overpayments to providers from three to five years.
The current presidential administration and Congress may pursue significant changes to the current healthcare laws. We face uncertainties that might result from modifications or repeal of any of the provisions of the Affordable Care Act, including as a result of current and future executive orders and legislative actions. The impact of those changes on us and potential effect on the medical device industry as a whole is currently unknown. Any changes to the Affordable Care Act are likely to have an impact on our results of operations, and may negatively affect our business, financial condition and results of operations. We cannot predict what other healthcare programs and regulations will ultimately be implemented at the federal or state level or the effect of any future legislation or regulation in the United States may negatively affect our business, financial condition and results of operations.
The continuing efforts of the government, insurance companies, managed care organizations and other payors of healthcare services to contain or reduce costs of healthcare will harm:
•our ability to set a price that we believe is fair for the Zephyr Valve;
•our ability to generate revenue and achieve or maintain profitability; and
•the availability of capital.
93
We expect that additional state and federal healthcare reform measures will be adopted in the future, particularly in light of the new presidential administration. Changes in healthcare policy could increase our costs and subject us to additional regulatory requirements that may interrupt commercialization of our current and future solutions. Changes in healthcare policy could increase our costs, decrease our revenue and impact sales of and reimbursement for our current and future products. Further, it is possible that additional governmental action is taken in response to the COVID-19 pandemic.
Legal, political and economic uncertainty surrounding the exit of the United Kingdom from the European Union may be a source of instability in international markets, create significant currency fluctuations, adversely affect our operations in the United Kingdom and pose additional risks to our business, financial condition and results of operations.
The United Kingdom ceased to be a member state of the European Union on January 31, 2020 (commonly referred to as “Brexit”), and the transition period provided for in the withdrawal agreement entered by the United Kingdom and the European Union ended on December 31, 2020. In December 2020, the United Kingdom and the European Union agreed on a trade and cooperation agreement that applies provisionally until it is ratified by the parties to the agreement. The trade and cooperation agreement covers the general objectives and framework of the relationship between the United Kingdom and the European Union, including with respect to trade, transport, visas, judicial matters, law enforcement and security matters, and provides for continued participation in community programs and mechanisms for dispute resolution. Because the trade and cooperation agreement merely sets forth a framework in many respects and will require complex additional bilateral negotiations between the United Kingdom and the European Union as both parties continue to work on the rules for implementation, significant political and economic uncertainty remains about how the precise terms of the relationship between the parties will differ from the terms before withdrawal.
Uncertainties remain regarding the application of the terms of the trade and cooperation agreement and the other potential impacts of Brexit, and the lack of clarity about future laws and regulations as the United Kingdom determines which European Union rules and regulations to replace or replicate, including financial laws and regulations, tax and free trade agreements, intellectual property rights, supply chain logistics, environmental, health and safety laws and regulations, immigration laws and employment laws, could decrease foreign direct investment in the United Kingdom, increase costs, depress economic activity and restrict access to capital. Possible changes to the rules and regulations relating to quality, safety and efficacy of products, clinical trials, marketing authorization, commercial sales and distribution of products could materially impact the regulatory regime with respect to products and approval of any product candidates in the United Kingdom or the European Union and we may be forced to restrict or delay efforts to sell our products or seek regulatory approval of product candidates in the United Kingdom and/or the European Union, which could negatively affect our business, financial condition and results of operations. The long-term effects of Brexit will depend on the implementation of the trade and cooperation agreement and any other agreements (or lack thereof) between the United Kingdom and the European Union and, in particular, any arrangements for the United Kingdom to retain access to European Union markets following the expiry of the Transition Period.
We are subject to governmental regulation and other legal and contractual obligations, particularly related to privacy, data protection and information security, and we are subject to consumer protection laws that regulate our consumer-facing practices and prohibit unfair or deceptive acts or practices. Our actual or perceived failure to comply with such obligations could harm our business.
We are subject to diverse laws and regulations relating to data privacy and security, including, in the United States, HIPAA and, in the European Union and the EEA, the General Data Protection Regulation (GDPR). New privacy rules are being enacted in the United States and globally, and existing ones are being updated and strengthened. For example, the California Consumer Privacy Act (CCPA) took effect on January 1, 2020 and creates individual privacy rights for California consumers and increases the privacy and security obligations of entities handling certain personal information.
94
The CCPA provides for civil penalties for violations, as well as a private right of action for data breaches that is expected to increase data breach litigation. Complying with these numerous, complex and often changing regulations is expensive and difficult, and failure to comply with any privacy laws or data security laws or any security incident or breach involving the misappropriation, loss or other unauthorized use or disclosure of sensitive or confidential patient or consumer information, whether by us, one of our business associates or another third-party, could negatively affect our business, financial condition and results of operations, including but not limited to: investigation costs, material fines and penalties; compensatory, special, punitive and statutory damages; litigation; consent orders regarding our privacy and security practices; requirements that we provide notices, credit monitoring services or credit restoration services or other relevant services to impacted individuals; adverse actions against our licenses to do business; and injunctive relief.
The privacy laws in the European Union have also been significantly reformed. On May 25, 2018, the GDPR entered into force and became directly applicable in all European Union member states. The GDPR implements more stringent operational requirements than its predecessor legislation. For example, the GDPR requires us to make more detailed disclosures to data subjects, requires disclosure of the legal basis on which we can process personal data, makes it harder for us to obtain valid consent for processing, require the appointment of data protection officers when sensitive personal data, such as health data, is processed on a large scale, provides more robust rights for data subjects, introduces mandatory data breach notification through the European Union, imposes additional obligations on us when contracting with service providers and requires us to adopt appropriate privacy governance including policies, procedures, training and data audit. If we do not comply with our obligations under the GDPR, we could be exposed to fines of up to the greater of €20 million or up to 4% of our total global annual revenue in the event of a significant breach. In addition, we may be the subject of litigation or adverse publicity, which could negatively affect our business, financial condition and results of operations.
Although there are legal mechanisms to allow for the transfer of personal data from the United Kingdom, EEA and Switzerland to the United States, uncertainty about compliance with such data protection laws remains and such mechanisms may not be available or applicable with respect to the personal data processing activities necessary to research, develop and market our products and services. For example, legal challenges in Europe to the mechanisms allowing companies to transfer personal data from the EEA to the United States could result in further limitations on the ability to transfer personal data across borders, particularly if governments are unable or unwilling to reach new or maintain existing agreements that support cross-border data transfers, such as the EU-U.S. and Swiss-U.S. Privacy Shield Frameworks, or the Privacy Shield Frameworks. Specifically, on July 16, 2020, the Court of Justice of the European Union invalidated Decision 2016/1250 which had deemed the protection provided by the EU-U.S. Privacy Shield Framework adequate under EU privacy law, specifically under the GDPR. To the extent that we or any of our vendors, contractors, or consultants have been relying on the EU-U.S. Privacy Shield Framework, we will not be able to do so in the future, which could increase our costs and may limit our ability to process personal data from the EU. The same decision also cast doubt on the ability to use one of the primary alternatives to the Privacy Shield Frameworks, namely, the European Commission’s Standard Contractual Clauses, to lawfully transfer personal data from Europe to the United States and most other countries. At present, there are few if any viable alternatives to the Privacy Shield Frameworks and the Standard Contractual Clauses for the foregoing purposes.
Further, Brexit has created uncertainty with regard to data protection regulation in the United Kingdom. In particular, while the Data Protection Act of 2018, that implements and complements the GDPR achieved Royal Assent on May 23, 2018 and is now effective in the United Kingdom, it is still unclear whether transfer of data from the EEA to the United Kingdom will remain lawful under the GDPR. During the period of “transition” (i.e., until December 31, 2020), EU law will continue to apply in the United Kingdom, including the GDPR, after which the GDPR will be converted into UK law. Beginning in 2021, the United Kingdom will be a “third country” under the GDPR. We may, however, incur liabilities, expenses, costs, and other operational losses under the GDPR and privacy laws of the applicable EU Member States and the United Kingdom in connection with any measures we take to comply with them.
We cannot assure you that our third-party service providers with access to our or our customers’, suppliers’, trial patients’ and employees’ personally identifiable and other sensitive or confidential information in relation to which we are responsible will not breach contractual obligations imposed by us, or that they will not experience data
95
security breaches or attempts thereof, which could have a corresponding effect on our business, including putting us in breach of our obligations under privacy laws and regulations, which could in turn adversely affect our business, results of operations and financial condition. We cannot assure you that our contractual measures and our own privacy and security-related safeguards will protect us from the risks associated with the third-party processing, storage and transmission of such information. Increasing use of social media could also give rise to liability, breaches of data security or reputational damage.
Moreover, complying with the various cybersecurity or privacy laws that are applicable to us could require us to take on more onerous obligations in our contracts, restrict our ability to collect, use and disclose data, or in some cases, impact our ability to operate in certain jurisdictions. Any failure to comply could result in government enforcement actions (which could include civil or criminal penalties), private litigation and/or adverse publicity and could negatively affect our operating results and business. Claims that we have violated individuals’ privacy rights, failed to comply with data protection laws, or breached our contractual obligations, even if we are not found liable, could be expensive and time consuming to defend, could result in adverse publicity and could have a material adverse effect on our business, financial condition, and results of operations.
We face potential liability related to the privacy of health information we obtain.
Most healthcare providers, including hospitals from which we obtain patient health information, are subject to privacy and security regulations promulgated under HIPAA, as amended by the HITECH. We are not currently classified as a covered entity or business associate under HIPAA and thus are not subject to its requirements or penalties. However, any person may be prosecuted under HIPAA’s criminal provisions either directly or under aiding-and-abetting or conspiracy principles. Consequently, depending on the facts and circumstances, we could face substantial criminal penalties if we knowingly receive individually identifiable health information from a HIPAA-covered healthcare provider or research institution that has not satisfied HIPAA’s requirements for disclosure of individually identifiable health information. In addition, we may maintain sensitive personally identifiable information, including health information, that we receive throughout the clinical trial process, in the course of our research collaborations, and directly from individuals (or their healthcare providers) who enroll in our patient reimbursement support programs. As such, we may be subject to state laws requiring notification of affected individuals and state regulators in the event of a breach of personal information, which is a broader class of information than the health information protected by HIPAA. Our clinical trial programs outside the United States may implicate international data protection laws, including the European Union Data Protection Directive and legislation of the European Union member states implementing it.
Our activities outside the United States impose additional compliance requirements and generate additional risks of enforcement for noncompliance. Failure by third-party contractors to comply with the strict rules on the transfer of personal data outside of the European Union into the United States may result in the imposition of criminal and administrative sanctions on such collaborators, which could adversely affect our business. Furthermore, certain health privacy laws, data breach notification laws, consumer protection laws and genetic testing laws may apply directly to our operations or those of our collaborators and may impose restrictions on our collection, use and dissemination of individuals’ health information.
Moreover, patients about whom we or our collaborators obtain health information, as well as the providers who share this information with us, may have statutory or contractual rights that limit our ability to use and disclose the information. We may be required to expend significant capital and other resources to ensure ongoing compliance with applicable privacy and data security laws. Claims that we have violated individuals’ privacy rights or breached our contractual obligations, even if we are not found liable, could be expensive and time consuming to defend and could result in adverse publicity that could negatively affect our business, financial condition and results of operations. If we or third-party contractors or consultants fail to comply with applicable federal, state or local regulatory requirements, we could be subject to a range of regulatory actions that could affect our or our contractors’ ability to develop and commercialize our product candidates and could harm or prevent sales of any affected products that we are able to commercialize, or could substantially increase the costs and expenses of developing, commercializing and marketing our products. Any threatened or actual government enforcement action could also
96
generate adverse publicity and require that we devote substantial resources that could otherwise be used in other aspects of our business.
Our employees, consultants, and other commercial partners may engage in misconduct or other improper activities, including non-compliance with regulatory standards and requirements.
We are exposed to the risk that our employees, consultants, and other commercial partners and business associates may engage in fraudulent or illegal activity. Misconduct by these parties could include intentional, reckless or negligent conduct or other unauthorized activities that violate the regulations of the FDA and non-U.S. regulators, including those laws requiring the reporting of true, complete and accurate information to such regulators, manufacturing standards, healthcare fraud and abuse laws and regulations in the United States and internationally or laws that require the true, complete and accurate reporting of financial information or data. In particular, sales, marketing and business arrangements in the healthcare industry, including the sale of medical devices, are subject to extensive laws and regulations intended to prevent fraud, misconduct, kickbacks, self-dealing and other abusive practices. These laws and regulations may restrict or prohibit a wide range of pricing, discounting, marketing and promotion, sales commission, customer incentive programs and other business arrangements. It is not always possible to identify and deter misconduct by our employees, consultants and other third parties, and the precautions we take to detect and prevent this activity may not be effective in controlling unknown or unmanaged risks or losses or in protecting us from governmental investigations or other actions or lawsuits stemming from a failure to comply with these laws or regulations. If any such actions are instituted against us and we are not successful in defending ourselves or asserting our rights, those actions could result in the imposition of significant fines or other sanctions, including the imposition of civil, criminal and administrative penalties, damages, monetary fines, possible exclusion from participation in Medicare, Medicaid and other federal healthcare programs, contractual damages, reputational harm, diminished profits and future earnings, and curtailment of operations, any of which could adversely affect our ability to operate our business and our results of operations. Whether or not we are successful in defending against such actions or investigations, we could incur substantial costs, including legal fees and reputational harm, and divert the attention of management in defending ourselves against any of these claims or investigations.
Compliance with environmental laws and regulations could be expensive, and the failure to comply with these laws and regulations could subject us to significant liability.
Our research, development and manufacturing operations involve the use of hazardous substances, and we are subject to a variety of federal, state, local and foreign environmental laws and regulations relating to the storage, use, handling, generation, manufacture, treatment, discharge and disposal of hazardous substances. Our products may also contain hazardous substances, and they are subject laws and regulations relating to labeling requirements and to their sale, collection, recycling, treatment, storage and disposal. Compliance with these laws and regulations may be expensive and noncompliance could result in substantial fines and penalties. Environmental laws and regulations also impose liability for the remediation of releases of hazardous substances into the environment and for personal injuries resulting from exposure to hazardous substances, and they can give rise to substantial remediation costs and to third-party claims, including for property damage and personal injury. Liability under environmental laws and regulations can be joint and several and without regard to fault or negligence, and they tend to become more stringent over time, imposing greater compliance costs and increased risks and penalties associated with violations. We cannot assure you that violations of these laws and regulations, or releases of or exposure to hazardous substances, will not occur in the future or have not occurred in the past, including as a result of human error, accidents, equipment failure or other causes. The costs of complying with environmental laws and regulations, and liabilities that may be imposed for violating them, or for remediation obligations or responding to third-party claims, could negatively affect our business, financial condition and results of operations.
97
Risks Related to Our Intellectual Property
We may become a party to intellectual property litigation or administrative proceedings that could be costly and could interfere with our ability to sell and market our products.
The medical device industry has been characterized by extensive litigation regarding patents, trademarks, trade secrets, and other intellectual property rights, and companies in the industry have used intellectual property litigation to gain a competitive advantage. It is possible that U.S. and foreign patents and pending patent applications or trademarks controlled by third parties may be alleged to cover our products, or that we may be accused of misappropriating third parties’ trade secrets. Additionally, our products include components that we purchase from vendors, and may include design components that are outside of our direct control. Our competitors, many of which have substantially greater resources and have made substantial investments in patent portfolios, trade secrets, trademarks, and competing technologies, may have applied for or obtained, or may in the future apply for or obtain, patents or trademarks that will prevent, limit or otherwise interfere with our ability to make, use, sell or export our products or to use our technologies or product names. Moreover, in recent years, individuals and groups that are non-practicing entities, commonly referred to as patent trolls, have purchased patents and other intellectual property assets for the purpose of making claims of infringement in order to extract settlements. From time to time, we may receive threatening letters, notices or invitations to license, or may be the subject of claims that our products and business operations infringe or violate the intellectual property rights of others. The defense of these matters can be time consuming, costly to defend in litigation, divert management’s attention and resources, damage our reputation and brand and cause us to incur significant expenses or make substantial payments. Vendors from whom we purchase hardware or software may not indemnify us in the event that such hardware or software is accused of infringing a third-party’s patent or trademark or of misappropriating a third-party’s trade secret.
Since patent applications are confidential for a period of time after filing, we cannot be certain that we were the first to file any patent application related to our products. Competitors may also contest our patents, if issued, by showing the patent examiner that the invention was not original, was not novel or was obvious. In litigation, a competitor could claim that our patents, if issued, are not valid for a number of reasons. If a court agrees, we would lose our rights to those challenged patents. Because we have not conducted a formal freedom to operate analysis for patents related to our products, we may not be aware of issued patents that a third party might assert are infringed by one of our current products or future product candidates, which could materially impair our ability to commercialize our products or product candidates. Even if we diligently search third-party patents for potential infringement by our products or product candidates, we may not successfully find patents that our products or product candidates may infringe. If we are unable to secure and maintain freedom to operate, others could preclude us from commercializing our products or product candidates.
In addition, we may in the future be subject to claims by our former employees or consultants asserting an ownership right in our patents, patent applications or other intellectual property, as a result of the work they performed on our behalf. Although we generally require all of our employees and consultants and any other partners or collaborators who have access to our proprietary know-how, information or technology to assign or grant similar rights to their inventions to us, we cannot be certain that we have executed such agreements with all parties who may have contributed to our intellectual property, nor can we be certain that our agreements with such parties will be upheld in the face of a potential challenge, or that they will not be breached, for which we may not have an adequate remedy.
Any lawsuits relating to intellectual property rights could subject us to significant liability for damages and invalidate our proprietary rights. Any potential intellectual property litigation also could force us to do one or more of the following:
•stop making, selling or using products or technologies that allegedly infringe the asserted intellectual property;
98
•lose the opportunity to license our intellectual property to others or to collect royalty payments based upon successful protection and assertion of our intellectual property rights against others; incur significant legal expenses;
•pay substantial damages or royalties to the party whose intellectual property rights we may be found to be infringing;
•pay the attorney’s fees and costs of litigation to the party whose intellectual property rights we may be found to be infringing;
•redesign those products or technologies that contain the allegedly infringing intellectual property, which could be costly, disruptive and infeasible; and
•attempt to obtain a license to the relevant intellectual property from third parties, which may not be available on reasonable terms or at all, or from third parties who may attempt to license rights that they do not have.
In addition, if we are found to willfully infringe third-party patents or trademarks or to have misappropriated trade secrets, we could be required to pay treble damages in addition to other penalties. Although patent, trademark, trade secret, and other intellectual property disputes in the medical device area have often been settled through licensing or similar arrangements, costs associated with such arrangements may be substantial and could include ongoing royalties. We may be unable to obtain necessary licenses on satisfactory terms, if at all. If we do not obtain necessary licenses, we may not be able to redesign our products to avoid infringement.
Any litigation or claim against us, even those without merit and even those where we prevail, may cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If we are found to infringe the intellectual property rights of third parties, we could be required to pay substantial damages (which may be increased up to three times of awarded damages) or substantial royalties and could be prevented from selling our products unless we obtain a license or are able to redesign our products to avoid infringement. Any such license may not be available on reasonable terms, if at all, and there can be no assurance that we would be able to redesign our products in a way that would not infringe the intellectual property rights of others. We could encounter delays in product introductions while we attempt to develop alternative methods or products. If we fail to obtain any required licenses or make any necessary changes to our products or technologies, we may have to withdraw existing products from the market or may be unable to commercialize one or more of our products.
In addition, we generally indemnify our customers with respect to infringement by our products of the proprietary rights of third parties. Third parties may assert infringement claims against our customers. These claims may require us to initiate or defend protracted and costly litigation on behalf of our customers, regardless of the merits of these claims. If any of these claims succeed or settle, we may be forced to pay damages or settlement payments on behalf of our customers or may be required to obtain licenses for the products they use. If we cannot obtain all necessary licenses on commercially reasonable terms, our customers may be forced to stop using our products.
Similarly, interference or derivation proceedings provoked by third parties or brought by the U.S. Patent and Trademark Office (USPTO) may be necessary to determine priority with respect to our patents, patent applications, trademarks or trademark applications. We may also become involved in other proceedings, such as reexamination, inter parties review, derivation or opposition proceedings before the USPTO or other jurisdictional body relating to our intellectual property rights or the intellectual property rights of others. Adverse determinations in a judicial or administrative proceeding or failure to obtain necessary licenses could prevent us from manufacturing our products or using product names, which would have a significant adverse impact on our business, financial condition and results of operations.
Additionally, we may file lawsuits or initiate other proceedings to protect or enforce our patents or other intellectual property rights, which could be expensive, time consuming and unsuccessful. Competitors may infringe our issued
99
patents or other intellectual property. To counter infringement or unauthorized use, we may be required to file infringement claims, which can be expensive and time-consuming. Any claims we assert against perceived infringers could provoke these parties to assert counterclaims against us alleging that we infringe their intellectual property. In addition, in a patent or other intellectual property infringement proceeding, a court may decide that a patent or other intellectual property of ours is invalid or unenforceable, in whole or in part, construe the patent’s claims or other intellectual property narrowly or refuse to stop the other party from using the technology at issue on the grounds that our patents or other intellectual property do not cover the technology in question. Furthermore, even if our patents or other intellectual property are found to be valid and infringed, a court may refuse to grant injunctive relief against the infringer and instead grant us monetary damages or ongoing royalties. Such monetary compensation may be insufficient to adequately offset the damage to our business caused by the infringer’s competition in the market. An adverse result in any litigation proceeding could put one or more of our patents or other intellectual property at risk of being invalidated or interpreted narrowly, which could adversely affect our competitive business position, financial condition and results of operations.
Our success will depend on our, and any of our current and future licensors’, ability to obtain, maintain and protect our intellectual property rights.
In order to remain competitive, we must develop, maintain and protect the proprietary aspects of our brands, technologies and data. We rely on a combination of contractual provisions, confidentiality procedures and patent, copyright, trademark, trade secret and other intellectual property laws to protect the proprietary aspects of our brands, technologies and data. These legal measures afford only limited protection, and competitors or others may gain access to or use our intellectual property and proprietary information. Our success will depend, in part, on preserving our trade secrets, maintaining the security of our data and know-how and obtaining and maintaining other intellectual property rights by us and our current and future licensors. We, and our current and future licensors, may not be able to obtain or maintain intellectual property or other proprietary rights necessary to our business or in a form that provides us with a competitive advantage.
In addition, our trade secrets, data and know-how could be subject to unauthorized use, misappropriation, or disclosure to unauthorized parties, despite our efforts to enter into confidentiality agreements with our employees, consultants, clients and other vendors who have access to such information, and could otherwise become known or be independently discovered by third parties. Our intellectual property, including trademarks, could be challenged, invalidated, infringed, and circumvented by third parties, and our trademarks could also be diluted, declared generic or found to be infringing on other marks. If any of the foregoing occurs, we could be forced to re-brand our products, resulting in loss of brand recognition and requiring us to devote resources to advertising and marketing new brands, and suffer other competitive harm. Third parties may also adopt trademarks similar to ours, which could harm our brand identity and lead to market confusion. Failure to obtain and maintain intellectual property rights necessary to our business and failure to protect, monitor and control the use of our intellectual property rights could negatively impact our ability to compete and cause us to incur significant expenses. The intellectual property laws and other statutory and contractual arrangements in the United States and other jurisdictions we depend upon may not provide sufficient protection in the future to prevent the infringement, use, violation or misappropriation of our trademarks, data, technology and other intellectual property and services, and may not provide an adequate remedy if our intellectual property rights are infringed, misappropriated or otherwise violated.
We rely, in part, on our ability to obtain, maintain, expand, enforce, and defend the scope of our intellectual property portfolio or other proprietary rights, including the amount and timing of any payments we may be required to make in connection with the licensing, filing, defense and enforcement of any patents or other intellectual property rights. The process of applying for and obtaining a patent is expensive, time consuming and complex, and we may not be able to file, prosecute, maintain, enforce or license all necessary or desirable patent applications at a reasonable cost, in a timely manner, or in all jurisdictions where protection may be commercially advantageous, or we may not be able to protect our proprietary rights at all. Despite our efforts to protect our proprietary rights, unauthorized parties may be able to obtain and use information that we regard as proprietary. In addition, the issuance of a patent does not ensure that it is valid or enforceable, so even if we obtain patents, they may not be valid or enforceable against third parties. Our patent applications may not result in issued patents and our patents may not be sufficiently broad to protect our technology.
100
The degree of future protection for our proprietary rights is uncertain, and we cannot ensure that:
•any of our patents, or any of our pending patent applications, if issued, will include claims having a scope sufficient to protect our products;
•any of our pending patent applications will issue as patents;
•we will be able to successfully commercialize our products on a substantial scale, if approved, before our relevant patents we may have expire;
•we were the first to make the inventions covered by each of our patents and pending patent applications;
•we were the first to file patent applications for these inventions;
•others will not develop similar or alternative technologies that do not infringe our patents; any of our patents will be found to ultimately be valid and enforceable;
•any patents issued to us will provide a basis for an exclusive market for our commercially viable products, will provide us with any competitive advantages or will not be challenged by third parties;
•we will develop additional proprietary technologies or products that are separately patentable; or
•our commercial activities or products will not infringe upon the patents of others.
Moreover, even if we are able to obtain patent protection, such patent protection may be of insufficient scope to achieve our business objectives. Issued patents may be challenged, narrowed, invalidated or circumvented. Decisions by courts and governmental patent agencies may introduce uncertainty in the enforceability or scope of patents owned by or licensed to us. Furthermore, the issuance of a patent does not give us the right to practice the patented invention. Third parties may have blocking patents that could prevent us from marketing our own products and practicing our own technology. Alternatively, third parties may seek approval to market their own products similar to or otherwise competitive with our products. In these circumstances, we may need to defend or assert our patents, including by filing lawsuits alleging patent infringement. In any of these types of proceedings, a court or agency with jurisdiction may find our patents invalid, unenforceable or not infringed; competitors may then be able to market products and use manufacturing and analytical processes that are substantially similar to ours. Even if we have valid and enforceable patents, these patents still may not provide protection against competing products or processes sufficient to achieve our business objectives.
If we are unable to protect the confidentiality of our other proprietary information, our business and competitive position may be harmed.
In addition to patent protection, we also rely on other proprietary rights, including protection of trade secrets, and other proprietary information that is not patentable or that we elect not to patent. However, trade secrets can be difficult to protect, and some courts are less willing or unwilling to protect trade secrets. To maintain the confidentiality of our trade secrets and proprietary information, we rely heavily on confidentiality provisions that we have in contracts with our employees, consultants, collaborators and others upon the commencement of their relationship with us. We cannot guarantee that we have entered into such agreements with each party that may have or have had access to our trade secrets or proprietary technology and processes. We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by such third parties, despite the existence generally of these confidentiality restrictions. These contracts may not provide meaningful protection for our trade secrets, know-how, or other proprietary information in the event of any unauthorized use, misappropriation, or disclosure of such trade secrets, know-how, or other proprietary information. There can be no assurance that such third parties will not breach their agreements with us, that we will have adequate remedies for any breach, or that our trade secrets will not otherwise become known or independently developed by competitors. Despite the protections we do place on our intellectual property or other proprietary rights, monitoring unauthorized
101
use and disclosure of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our intellectual property or other proprietary rights will be adequate. In addition, the laws of many foreign countries will not protect our intellectual property or other proprietary rights to the same extent as the laws of the United States. Consequently, we may be unable to prevent our proprietary technology from being exploited abroad, which could affect our ability to expand to international markets or require costly efforts to protect our technology.
We also license rights to use certain proprietary information and technology from third parties. The use of such proprietary information and technology is therefore subject to the obligations of the applicable license agreement between us and the owner. For example, the software we developed for the Chartis System includes the use of open source software that is subject to the terms and conditions of the applicable open source software licenses that grant us permission to use such software. The owner of any such proprietary information or technology also might not enforce or otherwise protect its rights in the proprietary information or technology with the same vigilance that we would, which would allow competitors to use such proprietary information and technology without having to adhere to a license agreement with the owner.
To the extent our intellectual property or other proprietary information protection is incomplete, we are exposed to a greater risk of direct competition. A third party could, without authorization, copy or otherwise obtain and use our products or technology, or develop similar technology. Our competitors could purchase our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts or design around our protected technology. Our failure to secure, protect and enforce our intellectual property rights could substantially harm the value of our products, brand and business. The theft or unauthorized use or publication of our trade secrets and other confidential business information could reduce the differentiation of our products and harm our business, the value of our investment in development or business acquisitions could be reduced and third parties might make claims against us related to losses of their confidential or proprietary information. Any of the foregoing could materially and adversely affect our business, financial condition and results of operations.
Further, it is possible that others will independently develop the same or similar technology or product or otherwise obtain access to our unpatented technology, and in such cases, we could not assert any trade secret rights against such parties. Costly and time-consuming litigation could be necessary to enforce and determine the scope of our trade secret rights and related confidentiality and nondisclosure provisions. If we fail to obtain or maintain trade secret protection, or if our competitors obtain our trade secrets or independently develop technology or products similar to ours or competing technologies or products, our competitive market position could be materially and adversely affected. In addition, some courts are less willing or unwilling to protect trade secrets and agreement terms that address non-competition are difficult to enforce in many jurisdictions and might not be enforceable in certain cases.
We also seek to preserve the integrity and confidentiality of our data and other confidential information by maintaining physical security of our premises and physical and electronic security of our information technology systems. While we have confidence in these individuals, organizations and systems, agreements or security measures may be breached and detecting the disclosure or misappropriation of confidential information and enforcing a claim that a party illegally disclosed or misappropriated confidential information is difficult, expensive and time-consuming, and the outcome is unpredictable. Further, we may not be able to obtain adequate remedies for any breach.
Obtaining and maintaining patent protection depends on compliance with various procedural, document submission, fee payment and other requirements imposed by governmental patent agencies, and our patent protection could be reduced or eliminated for non‑compliance with these requirements.
The USPTO and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. In addition, periodic maintenance fees on issued patents often must be paid to the USPTO and foreign patent agencies over the lifetime of the patent. While an unintentional lapse can in many cases be cured by payment of a late fee or by other means in accordance with the applicable rules, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction.
102
Non‑compliance events that could result in abandonment or lapse of a patent or patent application include, but are not limited to, failure to respond to official actions within prescribed time limits, non‑payment of fees and failure to properly legalize and submit formal documents. If we fail to maintain the patents and patent applications covering our products, we may not be able to stop a competitor from marketing products that are the same as or similar to our products, which would have a material adverse effect on our business.
We may not be able to protect our intellectual property rights throughout the world.
A company may attempt to commercialize competing products utilizing our proprietary design, trademarks or tradenames in foreign countries where we do not have any patents or patent applications and where legal recourse may be limited. This may have a significant commercial impact on our foreign business operations.
Filing, prosecuting and defending patents or trademarks on our current and future products in all countries throughout the world would be prohibitively expensive. The requirements for patentability and trademarking may differ in certain countries, particularly developing countries. The laws of some foreign countries do not protect intellectual property rights to the same extent as laws in the United States. Consequently, we may not be able to prevent third parties from utilizing our inventions and trademarks in all countries outside the United States. Competitors may use our technologies or trademarks in jurisdictions where we have not obtained patent or trademark protection to develop or market their own products and further, may export otherwise infringing products to territories where we have patent and trademark protection, but enforcement on infringing activities is inadequate. These products or trademarks may compete with our products or trademarks, and our patents, trademarks or other intellectual property rights may not be effective or sufficient to prevent them from competing.
Many companies have encountered significant problems in protecting and defending intellectual property rights in foreign jurisdictions. The legal systems of certain countries, particularly certain developing countries, do not favor the enforcement of patents, trademarks and other intellectual property protection, which could make it difficult for us to stop the infringement of our patents and trademarks or marketing of competing products in violation of our proprietary rights generally. Proceedings to enforce our patent and trademarks rights in foreign jurisdictions could result in substantial costs and divert our efforts and attention from other aspects of our business, could put our patents and trademarks at risk of being invalidated or interpreted narrowly and our patent or trademark applications at risk, and could provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate, and the damages or other remedies awarded, if any, may not be commercially meaningful. In addition, certain countries in Europe and certain developing countries, including India and China, have compulsory licensing laws under which a patent owner may be compelled to grant licenses to third parties. In those countries, we may have limited remedies if our patents are infringed or if we are compelled to grant a license to our patents to a third party, which could materially diminish the value of those patents. This could limit our potential revenue opportunities. Accordingly, our efforts to enforce our intellectual property rights around the world may be inadequate to obtain a significant commercial advantage from the intellectual property that we own or license. Finally, our ability to protect and enforce our intellectual property rights may be adversely affected by unforeseen changes in foreign intellectual property laws.
We may be subject to claims that we or our employees have misappropriated the intellectual property of a third party, including trade secrets or know-how, or are in breach of non-competition or non-solicitation agreements with our competitors and third parties may claim an ownership interest in intellectual property we regard as our own.
Many of our employees and consultants were previously employed at or engaged by other medical device, biotechnology or pharmaceutical companies, including our competitors or potential competitors. Some of these employees, consultants and contractors, may have executed proprietary rights, non-disclosure and non-competition agreements in connection with such previous employment. Although we try to ensure that our employees and consultants do not use the intellectual property, proprietary information, know-how or trade secrets of others in their work for us, we may be subject to claims that we or these individuals have, inadvertently or otherwise, misappropriated the intellectual property or disclosed the alleged trade secrets or other proprietary information, of these former employers or competitors.
103
Additionally, we may be subject to claims from third parties challenging our ownership interest in intellectual property we regard as our own, based on claims that our employees or consultants have breached an obligation to assign inventions to another employer, to a former employer, or to another person or entity. Litigation may be necessary to defend against any other claims, and it may be necessary or we may desire to enter into a license to settle any such claim; however, there can be no assurance that we would be able to obtain a license on commercially reasonable terms, if at all. If our defense to those claims fails, in addition to paying monetary damages, a court could prohibit us from using technologies or features that are essential to our products, if such technologies or features are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. An inability to incorporate technologies or features that are important or essential to our products could have a material adverse effect on our business, financial condition and results of operations, and may prevent us from selling our products. In addition, we may lose valuable intellectual property rights or personnel. Even if we are successful in defending against these claims, litigation could result in substantial costs and could be a distraction to management. Any litigation or the threat thereof may adversely affect our ability to hire employees or contract with independent sales personnel. A loss of key personnel or their work product could hamper or prevent our ability to commercialize our products, which could have an adverse effect on our business, financial condition and results of operations.
Changes in patent law could diminish the value of patents in general, thereby impairing our ability to protect our existing and future products.
Recent patent reform legislation could increase the uncertainties and costs surrounding the prosecution of patent applications and the enforcement or defense of issued patents. In 2011, the Leahy-Smith America Invents Act (Leahy-Smith Act) was signed into law. The Leahy-Smith Act includes a number of significant changes to U.S. patent law. These include provisions that affect the way patent applications are prosecuted and also may affect patent litigation. These also include provisions that switched the United States from a first-to-invent system to a first-to-file system, allow third-party submission of prior art to the USPTO during patent prosecution and set forth additional procedures to attack the validity of a patent by the USPTO administered post grant proceedings. Under a first-to-file system, assuming the other requirements for patentability are met, the first inventor to file a patent application generally will be entitled to the patent on an invention regardless of whether another inventor had made the invention earlier. The USPTO recently developed new regulations and procedures to govern administration of the Leahy-Smith Act, and many of the substantive changes to patent law associated with the Leahy-Smith Act, and in particular, the first to file provisions, only became effective in 2013. Accordingly, it is not clear what, if any, impact the Leahy-Smith Act will have on the operation of our business. The Leahy-Smith Act and its implementation could increase the uncertainties and costs surrounding the prosecution of our patent applications and the enforcement or defense of our issued patents, all of which could have a material adverse effect on our business, financial condition and results of operations.
In addition, patent reform legislation may pass in the future that could lead to additional uncertainties and increased costs surrounding the prosecution, enforcement and defense of our patents and applications. Furthermore, the U.S. Supreme Court and the U.S. Court of Appeals for the Federal Circuit have made, and will likely continue to make, changes in how the patent laws of the United States are interpreted. Similarly, foreign courts have made, and will likely continue to make, changes in how the patent laws in their respective jurisdictions are interpreted. We cannot predict future changes in the interpretation of patent laws or changes to patent laws that might be enacted into law by U.S. and foreign legislative bodies. Those changes may materially affect our patents or patent applications and our ability to obtain additional patent protection in the future.
The failure of third parties to meet their contractual, regulatory and other obligations could adversely affect our business.
We rely on suppliers, vendors, outsourcing partners, consultants, alliance partners and other third parties to research, develop, manufacture and commercialize our products and manage certain parts of our business. Using these third parties poses a number of risks, such as: (i) they may not perform to our standards or legal requirements; (ii) they may not produce reliable results; (iii) they may not perform in a timely manner; (iv) they may not maintain confidentiality of our proprietary information; (v) disputes may arise with respect to ownership of rights to
104
technology developed with our partners; and (vi) disagreements could cause delays in, or termination of, the research, development or commercialization of our products or result in litigation or arbitration. Moreover, some third parties are located in markets subject to political and social risk, corruption, infrastructure problems and natural disasters, in addition to country-specific privacy and data security risk given current legal and regulatory environments. Failure of third parties to meet their contractual, regulatory and other obligations may materially affect our business.
If our trademarks and tradenames are not adequately protected, then we may not be able to build name recognition in our markets and our business may be adversely affected.
We rely on trademarks, service marks, tradenames and brand names to distinguish our products from the products of our competitors and have registered or applied to register these trademarks. We have not yet registered certain of our trademarks, including “CHARITE” in Germany, and as a result we sell certain products using names that may not be protected or may be subject to third party challenges for infringement of such third party’s trademarks. We cannot assure you that our trademark applications will be approved. During trademark registration proceedings, we may receive rejections. Although we are given an opportunity to respond to those rejections, we may be unable to overcome such rejections. In addition, in proceedings before the USPTO and comparable agencies in many foreign jurisdictions, third parties are given an opportunity to oppose pending trademark applications and to seek to cancel registered trademarks. Opposition or cancellation proceedings may be filed against our trademarks, and our trademarks may not survive such proceedings. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources towards advertising and marketing new brands. At times, competitors may adopt trade names or trademarks similar to ours, thereby impeding our ability to build brand identity and possibly leading to market confusion. Certain of our current or future trademarks may become so well known by the public that their use becomes generic and they lose trademark protection. Over the long term, if we are unable to establish name recognition based on our trademarks and trade names, then we may not be able to compete effectively and our business, financial condition and results of operations may be adversely affected.
Patent terms may not be able to protect our competitive position for an adequate period of time with respect to our current or future technologies.
Patents have a limited lifespan. In the United States, the standard patent term is typically 20 years after filing. Various extensions may be available. Even so, the life of a patent and the protection it affords are limited. As a result, our patent portfolio provides us with limited rights that may not last for a sufficient period of time to exclude others from commercializing products similar or identical to ours. For example, given the large amount of time required for the research, development, testing and regulatory review of implantable medical devices, patents protecting our products might expire before or shortly after they are commercialized.
Extensions of patent term may be available, but there is no guarantee that we would succeed in obtaining any particular extension-and no guarantee any such extension would confer patent term for a sufficient period of time to exclude others from commercializing products similar or identical to ours. In the United States, 35 U.S. Code § 156 Extension of patent term, permits a patent term extension of up to five years beyond the normal expiration of the patent, which is limited to the approved indication (or any additional indications approved during the period of extension). A patent term extension cannot extend the remaining term of a patent beyond 14 years from the date of product approval; only one patent may be extended; and extension is available for only those claims covering the approved device, a method for using it, or a method for manufacturing it. We have applied for such an extension however, the applicable authorities, including the FDA and the USPTO in the United States, and any equivalent regulatory authority in other countries, may not agree with our assessment of whether such extensions are available, and may refuse to grant extensions to any patents we obtain, or may grant more limited extensions than we request. An extension may not be granted or may be limited where there is, for example, a failure to exercise due diligence during the testing phase or regulatory review process, failure to apply within applicable deadlines, failure to apply before expiration of relevant patents, or some other failure to satisfy applicable requirements. If this occurs, our competitors may be able to launch their products earlier by taking advantage of our investment in development and
105
clinical trials along with our clinical and pre-clinical data. This could have a material adverse effect on our business and ability to achieve profitability.
Risks Related to Ownership of Our Common Stock
Our stock price may be volatile and the value of our common stock may decline.
The market price of our common stock may be highly volatile and may fluctuate or decline substantially as a result of a variety of factors, some of which are beyond our control or are related in complex ways, including:
•actual or anticipated fluctuations in our financial condition and results of operations;
•variance in our financial performance from expectations of securities analysts or investors;
•changes in the pricing we offer our customers;
•changes in our projected operating and financial results;
•changes in laws or regulations applicable to our solution;
•announcements by us or our competitors of significant business developments, acquisitions, or new offerings;
•publicity associated with issues related to our solution;
•our involvement in litigation;
•future sales of our common stock or other securities, by us or our stockholders, as well as the anticipation of lock-up releases;
•changes in senior management or key personnel;
•the trading volume of our common stock;
•changes in the anticipated future size and growth rate of our market;
•general economic, regulatory, and market conditions, including economic recessions or slowdowns;
•changes in the structure of healthcare payment systems; and
•developments or disputes concerning our intellectual property or other proprietary rights.
In addition, the trading prices for common stock of other medical device companies have been highly volatile as a result of the COVID-19 pandemic. The COVID-19 pandemic continues to rapidly evolve. The extent to which the pandemic may impact our business will depend on future developments, which are highly uncertain and cannot be predicted with confidence.
Broad market and industry fluctuations, as well as general economic, political, regulatory, and market conditions, may negatively impact the market price of our common stock. In addition, given the relatively small expected public float of shares of our common stock on the Nasdaq Global Select Market, the trading market for our shares may be subject to increased volatility. In the past, companies that have experienced volatility in the market price of their securities have been subject to securities class action litigation. We may be the target of this type of litigation in the future, which could result in substantial costs and divert our management’s attention.
106
Future sales and issuances of our capital stock or rights to purchase capital stock could result in additional dilution of the percentage ownership of our stockholders and could cause the price of our common stock to decline.
Future sales and issuances of our capital stock or rights to purchase our capital stock could result in substantial dilution to our existing stockholders. We may sell common stock, convertible securities, and other equity securities in one or more transactions at prices and in a manner as we may determine from time to time. If we sell any such securities in subsequent transactions, investors may be materially diluted. New investors in such subsequent transactions could gain rights, preferences, and privileges senior to those of holders of our common stock.
Future sales of our common stock by existing stockholders could cause the market price of our common stock to decline.
Sales of a substantial number of shares of our common stock by existing stockholders in the public market, or the perception that these sales might occur, could depress the market price of our common stock and could impair our ability to raise capital through the sale of additional equity securities. We are unable to predict the effect that such sales may have on the prevailing market price of our common stock.
As of December 31, 2020, we had outstanding 35,693,753 shares of common stock. All of our executive officers and directors and substantially all of our other existing security holders are subject to lock-up agreements in connection with our IPO under which they have agreed, subject to specific exceptions, not to sell any of our capital stock until March 29, 2020. After the lock-up agreements expire, substantially all of such shares will become eligible for sale in the public market, of which 13,240,449 shares held by directors, executive officers, and other affiliates will be subject to volume limitations under Rule 144 under the Securities Act of 1933, as amended (Securities Act), and various vesting agreements.
Moreover, 180 days after the closing of the initial public offering, holders of up to an aggregate of 18,680,478 shares of our common stock have rights, subject to some conditions, to require us to file registration statements for the public resale of the common stock or to include such shares in registration statements that we may file on our behalf or for other stockholders.
Concentration of ownership of our common stock among our executive officers, directors and principal stockholders may prevent new investors from influencing significant corporate decisions.
Our executive officers, directors and current beneficial owners of 5% or more of our common stock beneficially own approximately 37% of our outstanding common stock as of December 31, 2020. These stockholders, acting together, will be able to significantly influence all matters requiring stockholder approval, including the election and removal of directors and any merger or other significant corporate transactions. The interests of this group of stockholders may not coincide with the interests of other stockholders.
Some of these persons or entities may have interests different than yours. For example, because many of these stockholders purchased their shares at prices substantially below the price at which shares are currently being sold and have held their shares for a longer period, they may be more interested in selling our company to an acquirer than other investors, or they may want us to pursue strategies that deviate from the interests of other stockholders.
If securities or industry analysts do not publish research or publish unfavorable or inaccurate research about our business, our common stock price and trading volume could decline.
Our stock price and trading volume is heavily influenced by the way analysts and investors interpret our financial information and other disclosures. If securities or industry analysts do not publish research or reports about our business, delay publishing reports about our business, or publish negative reports about our business, regardless of accuracy, our common stock price and trading volume could decline.
107
The trading market for our common stock depends, in part, on the research and reports that securities or industry analysts publish about us or our business. We do not have any control over these analysts. If the number of analysts that cover us declines, demand for our common stock could decrease and our common stock price and trading volume may decline.
Even if our common stock is actively covered by analysts, we do not have any control over the analysts or the measures that analysts or investors may rely upon to forecast our future results. Over-reliance by analysts or investors on any particular metric to forecast our future results may result in forecasts that differ significantly from our own.
Regardless of accuracy, unfavorable interpretations of our financial information and other public disclosures could have a negative impact on our stock price. If our financial performance fails to meet analyst estimates, for any of the reasons discussed above or otherwise, or one or more of the analysts who cover us downgrade our common stock or change their opinion of our common stock, our stock price would likely decline.
We do not intend to pay dividends for the foreseeable future and, as a result, your ability to achieve a return on your investment will depend on appreciation in the price of our common stock.
We have never declared or paid any cash dividends on our capital stock, and we do not intend to pay any cash dividends in the foreseeable future. Any determination to pay dividends in the future will be at the discretion of our board of directors and may be restricted by the terms of any then-current credit facility. Accordingly, investors must rely on sales of their common stock after price appreciation, which may never occur, as the only way to realize any future gains on their investments.
We are an “emerging growth company” and a “smaller reporting company” and our compliance with the reduced reporting and disclosure requirements applicable to emerging growth companies could make our common stock less attractive to investors.
For so long as we remain an “emerging growth company,” as defined in the JOBS Act, we may take advantage of certain exemptions from various requirements applicable to other public companies that are not “emerging growth companies” including, the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act (Section 404) reduced disclosure obligations regarding executive compensation in our periodic reports and proxy statements, exemptions from the requirements of holding a nonbinding advisory vote on executive compensation and stockholder approval of any golden parachute payments not previously approved. We cannot predict whether investors will find our common stock less attractive as a result of our reliance on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock and our stock price may be more volatile. We have not elected to use the extended transition period under the JOBS Act which would have allowed us to delay implementing new accounting standards, and, therefore, we will be subject to the same accounting standards as other public companies that are not “emerging growth companies.”
We are also a “smaller reporting company” as defined in the Exchange Act. We may continue to be a smaller reporting company even after we are no longer an “emerging growth company.” We may take advantage of certain of reduced disclosures available to smaller reporting companies and will be able to take advantage of these reduced disclosures for so long as our voting and non-voting common stock held by non-affiliates is less than $250.0 million measured on the last business day of our second fiscal quarter, or our annual revenue is less than $100.0 million during the most recently completed fiscal year and our voting and non-voting common stock held by non-affiliates is less than $700.0 million measured on the last business day of our second fiscal quarter.
We will incur increased costs as a result of operating as a public company, and our management will be required to devote substantial time to compliance with our public company responsibilities and corporate governance practices.
As a public company, we will incur significant legal, accounting, and other expenses that we did not incur as a private company. We expect such expenses to further increase after we are no longer an “emerging growth
108
company.” The Sarbanes-Oxley Act, the Dodd-Frank Wall Street Reform and Consumer Protection Act, the listing requirements of the Nasdaq Global Select Market, and other applicable securities rules and regulations impose various requirements on public companies. Furthermore, the senior members of our management team do not have significant experience with operating a public company. As a result, our management and other personnel will have to devote a substantial amount of time to compliance with these requirements. Moreover, these rules and regulations will increase our legal and financial compliance costs and will make some activities more time-consuming and costly.
As a result of being a public company, we are obligated to develop and maintain proper and effective internal controls over financial reporting and any failure to maintain the adequacy of these internal controls may adversely affect investor confidence in our company and, as a result, the value of our common stock.
We are required, pursuant to Section 404 to furnish a report by management on, among other things, the effectiveness of our internal control over financial reporting. This assessment will need to include disclosure of any material weaknesses identified by our management in our internal control over financial reporting. In addition, our independent registered public accounting firm will be required to attest to the effectiveness of our internal control over financial reporting in our first annual report required to be filed with the SEC following the date we are no longer an “emerging growth company.” The process of compiling the system and processing documentation necessary to perform the evaluation required under Section 404 is costly and challenging, and we may not be able to complete our evaluation, testing, and any required remediation in a timely fashion. Our compliance with Section 404 requires that we incur substantial accounting expense and expend significant management efforts. We currently do not have an internal audit group, and we will need to hire additional accounting and financial staff with appropriate public company experience and technical accounting knowledge to compile the system and process documentation necessary to perform the evaluation needed to comply with Section 404.
During the evaluation and testing process of our internal controls, if we identify one or more material weaknesses in our internal control over financial reporting, we will be unable to certify that our internal control over financial reporting is effective. We cannot assure you that there will not be material weaknesses or significant deficiencies in our internal control over financial reporting in the future. Any failure to maintain internal control over financial reporting could severely inhibit our ability to accurately report our financial condition or results of operations. If we are unable to conclude that our internal control over financial reporting is effective, or if our independent registered public accounting firm determines we have a material weakness or significant deficiency in our internal control over financial reporting, we could lose investor confidence in the accuracy and completeness of our financial reports, the market price of our common stock could decline and we could be subject to sanctions or investigations by the exchange on which our shares of common stock are listed, the SEC or other regulatory authorities. Failure to remedy any material weakness in our internal control over financial reporting, or to implement or maintain other effective control systems required of public companies, could also restrict our future access to the capital markets.
Anti-takeover provisions in our charter documents and under Delaware law could make an acquisition of our company more difficult, limit attempts by our stockholders to replace or remove our current management and limit the market price of our common stock.
Provisions in our amended and restated certificate of incorporation and amended and restated bylaws currently in effect may have the effect of delaying or preventing a change of control or changes in our management. Our amended and restated certificate of incorporation and amended and restated bylaws include provisions that:
•authorize our board of directors to issue, without further action by the stockholders, shares of undesignated preferred stock with terms, rights, and preferences determined by our board of directors that may be senior to our common stock;
•require that any action to be taken by our stockholders be effected at a duly called annual or special meeting and not by written consent;
109
•specify that special meetings of our stockholders can be called only by our board of directors, the chairperson of our board of directors, or our chief executive officer;
•establish an advance notice procedure for stockholder proposals to be brought before an annual meeting, including proposed nominations of persons for election to our board of directors;
•establish that our board of directors is divided into a number of classes, with each class serving staggered terms;
•prohibit cumulative voting in the election of directors;
•provide that our directors may be removed for cause only upon the vote of the holders of a majority of our outstanding shares of common stock;
•provide that vacancies on our board of directors may be filled only by a majority of directors then in office, even though less than a quorum; and
•require the approval of our board of directors or the holders of at least a majority of our outstanding shares of common stock to amend our bylaws and certain provisions of our certificate of incorporation.
These provisions may frustrate or prevent any attempts by our stockholders to replace or remove our current management by making it more difficult for stockholders to replace members of our board of directors, which is responsible for appointing the members of our management. In addition, because we are incorporated in Delaware, we are governed by the provisions of Section 203 of the Delaware General Corporation Law, which generally, subject to certain exceptions, prohibits a Delaware corporation from engaging in any of a broad range of business combinations with any interested stockholder for a period of three years following the date on which the stockholder became an interested stockholder. Any delay or prevention of a change of control transaction or changes in our management could cause the market price of our common stock to decline.
Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware and, to the extent enforceable, the federal district courts of the United States are the exclusive forums for substantially all disputes between us and our stockholders, which could limit our stockholders’ ability to obtain a favorable judicial forum for disputes with us or our directors, officers or employees.
Our amended and restated certificate of incorporation provides that the Court of Chancery of the State of Delaware (or, if the Court of Chancery of the State of Delaware lacks subject matter jurisdiction, any state court located within the State of Delaware or, if all such state courts lack subject matter jurisdiction, the federal district court for the District of Delaware) is the sole and exclusive forum for the following types of actions or proceedings under Delaware statutory or common law for:
•any derivative action or proceeding brought on our behalf;
•any action asserting a breach of fiduciary duty;
•any action asserting a claim against us arising under the Delaware General Corporation Law;
•our amended and restated certificate of incorporation or our amended and restated bylaws; and
•any action asserting a claim against us that is governed by the internal-affairs doctrine.
These provisions do not apply to suits brought to enforce a duty or liability created by the Exchange Act or any claim for which the federal district courts of the United States have exclusive jurisdiction. Furthermore, Section 22 of the Securities Act creates concurrent jurisdiction for federal and state courts over all such actions under the Securities Act and an investor cannot waive compliance with the federal securities laws and the rules and regulations
110
thereunder. Accordingly, both state and federal courts have jurisdiction to entertain such claims and there is uncertainty as to whether a court would enforce such a forum selection provision as written in connection with claims arising under the Securities Act. To prevent having to litigate claims in multiple jurisdictions and the threat of inconsistent or contrary rulings by different courts, among other considerations, our amended and restated certificate of incorporation further provides that the federal district courts of the United States are the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock shall be deemed to have notice of and to have consented to the provisions of our amended and restated certificate of incorporation described above. While the Delaware courts have determined that such choice of forum provisions are facially valid, a stockholder may nevertheless seek to bring a claim in a venue other than those designated in the exclusive forum provisions. In such instance, we would expect to vigorously assert the validity and enforceability of the exclusive forum provisions of our amended and restated certificate of incorporation. This may require significant additional costs associated with resolving such action in other jurisdictions and there can be no assurance that the provisions will be enforced by a court in those other jurisdictions.
These exclusive-forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers or other employees, which may discourage lawsuits against us and our directors, officers, and other employees. If a court were to find either exclusive-forum provision in our amended and restated certificate of incorporation to be inapplicable or unenforceable, we may incur further significant additional costs associated with resolving the dispute in other jurisdictions, all of which could seriously harm our business.
111
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
112
ITEM 2. PROPERTIES
Our corporate headquarters is located in Redwood City, California, where we lease and occupy approximately 25,000 square feet of office, manufacturing, and laboratory space. In addition, we lease various other office and warehouse spaces in Redwood City and Switzerland.
We believe our existing facilities are sufficient for our needs for the foreseeable future. To meet the future needs of our business, we may lease additional or alternate space, and we believe suitable additional or alternative space will be available in the future on commercially reasonable terms.
ITEM 3. LEGAL PROCEEDINGS
We are not a party to any material legal proceedings at this time. From time to time, we may be subject to various legal proceedings and claims that arise in the ordinary course of our business activities. Although the results of litigation and claims cannot be predicted with certainty, we do not believe we are party to any claim or litigation the outcome of which, if determined adversely to us, would individually or in the aggregate be reasonably expected to have a material adverse effect on our business. Regardless of the outcome, litigation can have an adverse impact on us because of defense and settlement costs, diversion of management resources and other factors.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
113
PART II
114
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Our common stock has been listed on the Nasdaq Global Select Market under the symbol “LUNG” since October 1, 2020. Prior to this date, there was no public market for our common stock.
Holders of Common Stock
As of March 4, 2021, there were approximately 358 holders of record of our common stock. The actual number of stockholders is greater than this number of holders of record and includes stockholders who are beneficial owners but whose shares are held in the street name by brokers and other nominees.
Dividend Policy
We currently intend to retain all available funds and any future earnings to fund the development and expansion of our business, and therefore we do not anticipate declaring or paying any cash dividends in the foreseeable future. Any future determination regarding the declaration and payment of dividends, if any, will be at the discretion of our board of directors and will depend on then-existing conditions, including our financial condition, operating results, contractual restrictions, capital requirements, business prospects and other factors our board of directors may deem relevant.
Recent Sales of Unregistered Securities
From January 1, 2020 through October 5, 2020, the date of closing of our IPO, we granted stock options and stock awards to employees, directors and consultants under our 2010 Equity Incentive plan, 2020 Stock Plan, and 2020 Equity Incentive Plan covering an aggregate of 1,416,271 shares of common stock, at a weighted average exercise price of $6.36 per share pursuant to our 2010 Equity Incentive plan, 2002 Stock Plan, and 2020 Equity Incentive Plan.
From January 1, 2020 through October 5, 2020, the date of closing of our IPO, we issued an aggregate of 1,711,621 shares of our common stock at a weighted-average purchase price of $1.55 per share to employees, directors and consultants for aggregate proceeds to us of approximately $2.7 million upon the exercise of stock options.
The offers, sales and issuances of the securities described above were deemed to be exempt from registration under Rule 701 promulgated under the Securities Act as transactions under compensatory benefit plans and contracts relating to compensation.
Use of Proceeds from Initial Public Offering
On September 30, 2020, our registration statement on Form S-1 (File No. 333-248635) relating to our initial public offering (“IPO”) of common stock became effective. The IPO closed on October 5, 2020 at which time we issued 11,500,000 shares of our common stock at a price of $19.00 per share, which included the issuance of shares in connection with the exercise by the underwriters of their option to purchase up to 1,500,000 additional shares. BofA Securities, Inc. and Morgan Stanley & Co. LLC acted as joint lead book-running managers for the IPO. Stifel, Nicolaus & Company, Incorporated, Wells Fargo Securities, LLC and Canaccord Genuity LLC acted lead managers for the IPO. We received an aggregate of $218.5 million gross proceeds, before underwriting discounts, commissions and offering costs, and approximately $201.4 million in net proceeds after deducting underwriting discounts and commissions and offering costs. None of the underwriting discounts and commissions or offering expenses were incurred or paid, directly or indirectly, to (i) our directors or officers or their associates, (ii) persons owning 10% or more of our common stock or (iii) any of our affiliates.
There has been no material change in our planned use of the net proceeds from our IPO as described in our final prospectus filed pursuant to Rule 424(b)(4) under the Securities Act with the SEC on October 1, 2020. No payments were made from our IPO proceeds directly or indirectly to our officers or directors, to persons owning 10% or more
115
of any class of our equity securities or to any of our affiliates, other than payments in the ordinary course of business to officers for salaries and to non-employee directors as compensation for service on our board or directors or service on a committee of our board of directors.
Purchases of Equity Securities by the Issuer and Affiliated Purchases
None.
116
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
You should read the selected historical financial data below in conjunction with Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and the consolidated financial statements and related notes included elsewhere in this Annual Report on Form 10-K. The selected financial data set forth below is derived from our audited consolidated financial statements and may not be indicative of future operating results.
| Years Ended December 31, | ||||||||||||||||||||
| 2020 | 2019 | 2018 | ||||||||||||||||||
| (in thousands, except share and per share amounts) | ||||||||||||||||||||
| Consolidated Statements of Operations Data: | ||||||||||||||||||||
| Revenue | $ | 32,733 | $ | 32,595 | $ | 20,004 | ||||||||||||||
| Cost of goods sold | 11,531 | 10,181 | 7,718 | |||||||||||||||||
| Gross profit | 21,202 | 22,414 | 12,286 | |||||||||||||||||
| Operating expenses: | ||||||||||||||||||||
| Research and development | 7,460 | 6,049 | 6,991 | |||||||||||||||||
| Selling, general and administrative | 46,074 | 34,203 | 20,347 | |||||||||||||||||
| Total operating expenses | 53,534 | 40,252 | 27,338 | |||||||||||||||||
| Loss from operations | (32,332) | (17,838) | (15,052) | |||||||||||||||||
| Interest income | 213 | 432 | 21 | |||||||||||||||||
| Interest expense | (3,181) | (2,317) | (2,520) | |||||||||||||||||
| Other income (expense), net | 3,282 | (617) | (916) | |||||||||||||||||
| Net loss before tax | (32,018) | (20,340) | (18,467) | |||||||||||||||||
| Income tax expense | 213 | 363 | 12 | |||||||||||||||||
| Net loss | $ | (32,231) | $ | (20,703) | $ | (18,479) | ||||||||||||||
| Net loss per share attributable to common stockholders, basic and diluted | $ | (3.16) | $ | (11.66) | $ | (11.03) | ||||||||||||||
| Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted | 10,184,841 | 1,776,110 | 1,674,779 | |||||||||||||||||
| As of December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| (in thousands) | |||||||||||||||||
| Consolidated Balance Sheet Data: | |||||||||||||||||
| Cash, cash equivalents and short-term marketable securities | $ | 231,561 | $ | 28,347 | $ | 4,124 | |||||||||||
Working capital(1) | 237,463 | 26,910 | 3,236 | ||||||||||||||
| Total assets | 263,708 | 53,533 | 15,013 | ||||||||||||||
| Term loan | 16,804 | 14,965 | 14,937 | ||||||||||||||
| Credit agreement | 564 | — | — | ||||||||||||||
| Total liabilities | 37,574 | 35,572 | 41,804 | ||||||||||||||
| Convertible preferred stock | — | 205,339 | 140,535 | ||||||||||||||
| Accumulated deficit | (242,734) | (210,503) | (189,800) | ||||||||||||||
| Total stockholders’ (deficit) equity | 226,134 | (187,378) | (167,326) | ||||||||||||||
_______________
(1)We define working capital as current assets less current liabilities. See our audited consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K for further details regarding our current assets and current liabilities as of December 31, 2020 and 2019.
117
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with Part II, Item 6, “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis and other parts of this Annual Report on Form 10-K contain forward-looking statements based upon current beliefs, plans and expectations related to future events and our future financial performance that involve risks, uncertainties and assumptions, such as statements regarding our intentions, plans, objectives, expectations, forecasts and projections. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under Part I, Item 1A, “Risk Factors” and elsewhere in this Annual Report on Form 10-K.
Overview
We are a commercial-stage medical technology company that provides a minimally invasive treatment for patients with severe emphysema, a form of chronic obstructive pulmonary disease (COPD). Our solution, which is comprised of the Zephyr Endobronchial Valve (Zephyr Valve), the Chartis Pulmonary Assessment System (Chartis System) and the StratX Lung Analysis Platform (StratX Platform), is designed to treat severe emphysema patients who, despite medical management, are still profoundly symptomatic and either do not want or are ineligible for surgical approaches. We estimate our solution currently addresses approximately 500,000 patients in the United States and 700,000 patients in select international markets, which represents a global market opportunity of approximately $12 billion.
We have a compelling body of clinical evidence with over 100 scientific articles published regarding the clinical benefits of Zephyr Valves, including in The New England Journal of Medicine, The Lancet and the American Journal of Respiratory and Critical Care Medicine. Multiple randomized controlled clinical trials have demonstrated that patients selected with the Chartis System and successfully treated with Zephyr Valves have shown statistically and clinically significant improvements in lung function, exercise capacity and quality of life compared to medical management alone.
In June 2018, we received pre-market approval (PMA) by the U.S. Food and Drug Administration (FDA) as a result of our breakthrough technology designation. The Zephyr Valve is now commercially available in more than 25 countries, with over 80,000 valves used to treat more than 20,000 patients through December 31, 2020. We have established reimbursement in major markets in North America, Europe and Asia Pacific and the Zephyr Valve has been included in treatment guidelines for COPD worldwide.
We market and sell our products in the United States through a direct sales organization consisting of 45 sales territory managers as of December 31, 2020. Our sales territory managers are focused on promoting awareness and increasing adoption of our solution primarily among the approximately 800 pulmonologists performing interventional pulmonary procedures and across approximately 500 high volume hospitals in the United States. We are expanding our commercial operations in the United States while continuing to foster our international growth. We employ both direct and distributor-based sales models, with over 90% of our revenue generated in markets where we sell directly.
In the United States, our solution is reimbursed based on established Category I Current Procedural Terminology (CPT) and ICD-10 Procedure Coding System (PCS) codes and associated APC and MS-DRG payment groupings. Current reimbursement in the United States is believed to cover the hospital costs of the procedure and related inpatient care. Commercial payors such as Aetna, Humana, Health Care Service Corporation have issued positive coverage policies for the Zephyr Valve, and United Healthcare no longer considers the procedure unproven or experimental. Medicare covers our solution for patients when medically necessary, and other commercial insurers are approving pre-authorization requests on a case-by-case basis. Outside the United States, our solution is covered by major health systems across much of Europe, Australia and South Korea.
118
We manufacture all our products at our headquarters located in Redwood City, California. This facility supports production and distribution operations, including manufacturing, quality control, raw material and finished goods storage. We have manufactured all our products at this facility for over ten years. We also store finished goods at secondary facilities. We seek to maintain higher levels of inventory to protect ourselves from supply interruptions and have an established distribution system for both U.S. and international customers.
To date, we have financed our operations primarily through the sale of equity securities, debt financing arrangements and sales of our products. We have devoted substantially all of our resources to research and development activities related to our solution, including clinical and regulatory initiatives to obtain marketing approval, sales and marketing activities, and investing in general and administrative infrastructure. We generated revenue of $32.7 million, with a gross margin of 64.8% and a net loss of $32.2 million, for the year ended December 31, 2020 compared to revenue of $32.6 million and $20.0 million, with a gross margin of 68.8% and 61.4% and a net loss of $20.7 million and $18.5 million, for the years ended December 31, 2019 and December 31, 2018, respectively. As of December 31, 2020, we had an accumulated deficit of $242.7 million, cash and cash equivalents of $231.6 million, and $17.4 million of outstanding term loans and credit agreements, net of debt discount and debt issuance costs.
On September 30, 2020, our Registration Statement on Form S-1 (File No. 333-248635) relating to our initial public offering (IPO), was declared effective by the Securities Exchange Commission, or SEC. Pursuant to the Registration Statement, we issued and sold an aggregate of 11,500,000 shares of common stock (inclusive of 1,500,000 shares pursuant to the exercise by the underwriters of their option) at a price of $19.00 per share for aggregate cash proceeds of $201.4 million, net of underwriting discounts, commissions and offering costs. The sale and issuance of 11,500,000 shares in the IPO closed on October 5, 2020. Upon the closing of the IPO on October 5, 2020, all outstanding shares of convertible preferred stock automatically converted into 17,797,026 shares of common stock. Subsequent to the closing of the IPO, there were no shares of preferred stock outstanding.
We have invested heavily in product development. Our research and development activities have been centered on driving continuous improvements to our solution. We have also made significant investments in clinical studies to demonstrate the safety and efficacy of the Zephyr Valve and to support regulatory submissions. We intend to make significant investments building our sales and marketing organization by increasing the number of sales territory managers and continuing our marketing efforts in existing and new markets throughout the United States, Europe and Asia Pacific. We also intend to continue to make investments in research and development efforts to develop our next generation products and support our future regulatory submissions to increase our addressable market and to expand indications and new markets. Because of these and other factors, we expect to continue to incur net losses for the next several years and we expect to require substantial additional funding, which may include future equity and debt financings.
Management believes that the Company’s existing cash and cash equivalents will allow the Company to continue its operations for at least the next 12 months from the issuance of our consolidated financial statements as of and for the year ended December 31, 2020.
Impact of the COVID-19 Pandemic
Since it was reported to have surfaced in December 2019, a novel strain of coronavirus (COVID-19) has spread across the world and has been declared a pandemic by the World Health Organization. Efforts to contain the spread of COVID-19 have been significant and governments around the world, including in the United States, Europe and Asia, have implemented travel restrictions, social distancing requirements, quarantines, stay-at-home orders and other significant measures which have also resulted in delay of clinical trials and FDA operations. Currently, the COVID-19 pandemic presents a substantial public health and economic challenge around the world and is adversely affecting our employees, including our sales force, hospitals, physicians, patients, communities and business operations, as well as contributing to significant volatility and negative pressure on the U.S. and world economy and in financial markets.
119
The COVID-19 pandemic has had a material adverse impact on our business, financial condition and results of operations by decreasing and delaying substantially all procedures performed using our products, and we expect the pandemic to continue to have a material adverse impact on our business, financial condition and results of operations for the foreseeable future. Similar to the general trend in elective and other surgical procedures, the number of procedures performed using our products has decreased substantially as healthcare organizations across the globe have prioritized the treatment of patients with COVID-19 or have altered their operations to prepare for and respond to the pandemic. In the markets in which we operate, elective, specialty and other procedures and appointments have been suspended or canceled to avoid non-essential patient exposure to medical environments and potential infection with COVID-19 and to focus limited resources and personnel capacity toward the treatment of COVID-19 patients.
In response to the COVID-19 pandemic, we have implemented a variety of measures intended to help us manage through its impact and position us to resume operations quickly and efficiently as restrictions, recommendations, and best practices evolve. These measures include:
•Establishing safety protocols, facility enhancements, and work-from-home strategies to protect our employees;
•Ensuring that our manufacturing and supply chain operations remain intact and operational, and building over four months of inventory;
•Keeping our workforce intact and continuing to build our team, including expansion of our U.S. sales force;
•Continuing to focus on new account openings and implementing virtual physician and sales force training programs;
•Accelerating our physician education programs and direct-to-patient marketing efforts through social media or other virtual forums;
•Increasing our capital base by $201.4 million through an initial public offering of our common stock in October 2020; and
•Continuing to invest in research and development activities in order to advance our AeriSeal clinical programs.
The COVID-19 pandemic has also adversely impacted the number of procedures using the Zephyr Valve as hospitals have had to, and continue to, focus on COVID-19 and as patients generally sought to postpone healthcare visits and treatments. Specifically, beginning in the second half of March 2020, procedures using our products were temporarily postponed or cancelled as COVID-19 spread to the various regions across the globe where we conduct our business and sell our products. Beginning in May 2020, we began to see signs of a recovery in our business, and by September 30, 2020 the total number of Zephyr Valves sold in the third quarter exceeded the total number of Zephyr Valves sold during the first quarter of 2020. In November and December 2020, a resurgence of COVID-19 led to a decrease in procedure volumes and our revenues in the fourth quarter of 2020 declined compared to revenues in the third quarter of 2020. The COVID-19 driven impact on procedure volumes extended through the first two months of 2021. We have seen initial indicators in March 2021 that the resurgence of COVID-19 is diminishing and we anticipate improving sales during 2021, assuming the efficacy, availability and delivery of vaccines as well as other societal responses to the pandemic. We are encouraged for the longer term, and we believe the following key indicators are contributing to the stabilization of our business:
•Continued opening of new accounts;
•Strong physician participation in virtual trainings;
120
•A strong patient pipeline evidenced by an increase in StratX report activity near to pre-COVID-19 levels, a rebound in patient calls into hospitals inquiring about our procedure, and a resumption of patient calls to our reimbursement support service; and
•Hospitals and centers beginning to accept patients for elective procedures.
Despite these signs of recovery of our business, we cannot be certain that any recovery will be sustained, or that a further resurgence of COVID-19 will not occur in 2021. We believe many of the measures adopted in response to, and challenges resulting, from COVID-19 will likely continue for the duration of the pandemic, which is uncertain, and are expected to continue to significantly reduce our revenue and adversely impact our business, financial condition and results of operations for the duration of the pandemic. As a result, we cannot assure you that our recent volume of Zephyr Valves sold are indicative of future results or that we will not experience additional adverse or materially adverse impacts associated with the COVID-19 pandemic. In particular, we believe the reduction in the backlog of patients who cancelled or postponed their procedures in the second quarter of 2020 contributed to the number of procedures and Zephyr Valves sold in the third and fourth quarters of 2020 as hospitals and centers resumed accepting patients for elective procedures. However, the number of Zephyr Valves sold in the future may decrease as the backlog of patients who have cancelled or postponed their procedures due to the COVID-19 pandemic is reduced. Further, once the COVID-19 pandemic subsides, there may be a substantial backlog of patients seeking appointments with physicians and surgeries to be performed at hospitals relating to a variety of medical conditions, and as a result, patients seeking treatment with Zephyr Valves may have to navigate limited provider capacity. We believe this limited provider and hospital capacity could have a material adverse effect on our business, financial condition and results of operations once the pandemic subsides and following the end of the pandemic. The extent to which the COVID-19 pandemic impacts our business will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity and spread of COVID-19 and variant strains, governmental and societal response to contain and treat COVID-19 and variant strains, and vaccination efforts, among others.
Our consolidated financial statements reflect judgments and estimates that could change in the future as a result of the COVID-19 pandemic. For more information regarding these risks and potential impacts, please refer to Part I, Item 1A, “Risk Factors.”
Factors Affecting our Business and Results of Operations
We believe there are several important factors that have impacted and that we expect will continue to impact our business and results of operations. These factors include:
Our Ability to Recruit, Train and Retain Our Sales Force and its Productivity
We have made, and intend to continue to make, significant investments in recruiting, training and retaining our direct sales force. This process requires significant education and training for our sales personnel to achieve the level of technical competency with our products that is expected by physicians and to gain experience building demand for our products. Upon completion of the training, our sales personnel typically require time in the field to grow their network of accounts and increase their productivity to the levels we expect. Successfully recruiting, training and retaining additional sales personnel will be required to achieve growth. In addition, inability to attract qualified sales personnel or the loss of any productive sales personnel would have a negative impact on our ability to grow our business.
We have in the past and expect in the future to enter into different compensation arrangements with our sales professionals, which include minimum guaranteed commissions. This has impacted our compensation expenses in the past and we expect it will do so in the future.
121
Physician, Patient and Hospital Awareness and Acceptance of Our Solution
Our goal is to establish our solution as a standard of care for severe emphysema. We intend to continue to promote awareness of our solution through training and educating physicians, pulmonary rehabilitation centers, key opinion leaders and various medical societies on the proven clinical benefits of Zephyr Valves. In addition, we intend to continue to publish additional clinical data in various industry and scientific journals and online and to present at various industry conferences. We plan to continue building patient awareness through our direct-to-patient marketing initiatives, which include advertising, social media and online education. We also intend to continue helping physicians in their outreach to patients and other healthcare providers. These efforts require significant investment by our marketing and sales organization, and vary depending upon the physician’s practice specialization, and personal preferences and geographic location of physicians, pulmonary rehabilitation centers and patients. In order to grow our business, we will need to continue to make significant investments in training and educating hospitals, physicians and patients on the advantages of our solution for the treatment of severe emphysema.
Third-Party Reimbursement
Since achieving regulatory approval in the United States in June 2018, we have launched the Zephyr Valve treatment and have made progress securing third-party payor reimbursement. The majority of our patients are Medicare beneficiaries. We estimate that roughly 75% of the potential Zephyr Valve patient population are Medicare/Medicaid beneficiaries, of which approximately 25% have managed Medicare/Medicaid and the remaining 50% have traditional Medicare/Medicaid. Approximately 25% of the potential Zephyr Valve patient population is under third-party commercial payor policies. A key element of our strategy remains to broaden our coverage by private third-party payor policies. Commercial payors such as Aetna, Humana, Health Care Service Corporation, and Highmark have issued positive coverage policies for the Zephyr Valve, and United Healthcare no longer considers the procedure unproven or experimental. Other commercial payors, such as many plans in the Blue Cross Blue Shield family of plans, do not yet consider our solution medically necessary, but these same plans are approving pre-authorization requests on a case-by-case basis. Medicare, currently without a public coverage policy, covers our solution for patients when medically necessary on a case-by-case basis and other commercial insurers not described above are approving pre-authorization requests on a case-by-case basis.
We have a dedicated patient reimbursement support team in the United States that works collaboratively with patients and providers to help secure the appropriate prior authorization approvals in advance of treatment. We continue to educate private insurers in the United States on our clinical data and patient selection tools in an effort to continue to expand the number of positive coverage policies, in order to increase our revenue. Outside the United States, our solution is covered by major health systems across much of Europe, Australia and South Korea.
Competition
Our industry is highly competitive and subject to rapid change from the introduction of new products and technologies and other activities of industry participants. Our goal is to establish our solution as a standard of care for severe emphysema. Existing treatments include medical management, lung volume reduction surgery (LVRS), lung transplantation as well as other minimally invasive treatments. Some of our competitors have several competitive advantages, including established relationships with pulmonologists who commonly treat patients with emphysema, significantly greater name recognition and significantly greater sales and marketing resources. In addition to competing for market share, we also compete against these companies for personnel, including qualified sales and other personnel that are necessary to grow our business. Certain of our competitors may challenge our intellectual property, may develop additional competing or superior technologies and processes and compete more aggressively and sustain that competition over a longer period of time than we could. In addition to existing competitors, other companies may acquire or in-license competitive products and could directly compete with us. We must continue to successfully compete in light of our competitors’ existing and future products and related pricing and their resources to successfully market to the physicians who use our products.
122
Leveraging Our Manufacturing Capacity is Critical to Improving Our Gross Margin
With our current operating model and infrastructure, we have the capacity to significantly increase our manufacturing production. If we grow our revenue and sell more units, our fixed manufacturing costs will be spread over more units, which we believe will reduce our manufacturing costs on a per-unit basis and in turn improve our gross margin. In addition, we intend to continue investing in manufacturing efficiencies in order to reduce our overall manufacturing costs. However, other factors will continue to impact our gross margins such as geographic mix, pricing and customer discounts, incentives, support services and potential seasonality.
Investing in Research and Development to Foster Innovation to Expand Our Addressable Market
We intend to continue investing in existing and next generation technologies to further improve our products and clinical outcomes, enhance patient selection and broaden the patient population that can be treated with our products. In addition, we are continuing to invest in the accuracy and features of our patient assessment tools. Moreover, we plan to conduct clinical research of AeriSeal, a potential product in development for the treatment of severe emphysema patients who are not qualified for Zephyr Valve treatment due to excessive collateral ventilation.
While research and development and clinical testing are time consuming and costly, we believe that a pipeline of new products and product enhancements that improve efficacy, safety and cost effectiveness is critical to increasing the adoption of our solution.
Seasonality
Historically, we have experienced seasonality outside of the United States, primarily in the first and third quarters and anticipate this trend to continue. In addition, as our sales grow in the United States, we may experience seasonality based on holidays, vacations and other factors because this is an elective procedure.
Components of Our Results of Operations
Revenue
We currently derive substantially all our revenue from the sale of our products to hospitals and distributors. We market and sell our products through a direct sales organization in the United States and through direct sales and several third-party distributors in select markets outside the United States. We currently generate most of our revenue from the sales of Zephyr Valves and delivery catheters. We also generate a smaller amount of our revenue from our Chartis System, which is comprised of sales of the balloon catheters, usage fees and sales of the Chartis console. The StratX Platform, while used to identify patients eligible for treatment with Zephyr Valves, does not independently generate any revenue for us. No single customer accounted for more than 10% of our revenue during the years ended December 31, 2020, 2019 and 2018.
Revenue from sales of our products fluctuates based on volume of cases (procedures performed), the average number of Zephyr Valves used for a patient, pricing, discounts, incentives and mix of U.S. and international sales. Our revenue also fluctuates and in the future will continue to fluctuate from quarter-to-quarter due to a variety of factors, including the availability of reimbursement, the size and success of our sales force, the number of hospitals and physicians who are aware of and perform the procedures using our solution and seasonality. Our revenue from international sales may also be impacted by fluctuations in foreign currency exchange rates between the U.S. dollar (our reporting currency) and the local currency.
Cost of Goods Sold and Gross Margin
Cost of goods sold consists primarily of payroll and personnel-related expenses for our manufacturing and quality assurance employees, costs related to materials, components and subassemblies, third-party costs, manufacturing overhead, equipment depreciation, charges for excess, obsolete and non-sellable inventories. Overhead costs include the cost of quality assurance, testing, material procurement, inventory control, operations supervision and
123
management and an allocation facilities overhead cost, including rent and utilities. Cost of goods sold also includes certain direct costs such as those incurred for shipping our products and costs related to providing analysis services for patient scans. We record adjustments to our inventory valuation for estimated excess, obsolete and non-sellable inventories based on assumptions about future demand, past usage, changes to manufacturing processes and overall market conditions. We expect cost of goods sold to increase in absolute dollars to the extent more of our products are sold.
We calculate gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily by our manufacturing costs, pricing pressures and, to a lesser extent, the percentage of products we sell in the United States versus internationally and the percentage of products we sell to distributors versus directly to hospitals. Our gross margin is typically higher on products we sell directly to hospitals as compared to products we sell through distributors.
Our gross margin may increase over the long term to the extent our production volume increases as our fixed manufacturing costs would be spread over a larger number of units, thereby reducing our per-unit manufacturing costs. We expect our gross margin to fluctuate from period to period, however, based upon the factors described above and seasonality.
Operating Expenses
Our operating expenses have consisted solely of research and development costs and selling, general and administrative costs.
Research and Development Expenses
Our research and development activities primarily consist of engineering and research programs associated with our products under development and improvements to our existing products. Research and development expenses include payroll and personnel-related costs for our research and development employees, including expenses related to stock-based compensation for employees engaged in research and development, consulting services, clinical trial expenses, regulatory expenses, prototyping, testing, laboratory supplies, and an allocation of facility overhead costs. Our clinical trial expenses include costs associated with clinical trial design, clinical trial site development and study costs, data management costs, related travel expenses, the cost of products used for clinical activities, and internal and external costs associated with our regulatory compliance. We expense research and development costs as they are incurred. We expect our research and development expenses, including related stock-based compensation expense, to increase in absolute dollars as we hire additional personnel to develop new product offerings and product enhancements.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist of payroll and personnel-related costs for our sales and marketing personnel, including variable sales compensation, travel expenses, consulting, public relations costs, direct marketing, customer training, trade show and promotional expenses, stock-based compensation and allocated facility overhead costs, and for administrative personnel that support our general operations such as information technology, executive management, financial accounting, customer services and human resources personnel. We expense sales variable compensation at the time of the sale. Selling, general and administrative expenses also include costs attributable to professional fees for legal and accounting services, insurance, consulting fees, recruiting fees, travel expense, bad debt expense and depreciation.
We intend to continue to increase the size of our sales force and our marketing spending to generate sales opportunities. We expect our sales and marketing expenses to increase in absolute dollars as we hire additional sales personnel and increase our sales support infrastructure and add additional marketing programs in order to more fully penetrate the global opportunity. We also expect our administrative expenses, including stock-based compensation expense, to increase as we increase our headcount and expand our facilities and information technology to support our operations as a public company. Additionally, we anticipate increased expenses related to audit, legal, regulatory
124
and tax-related services associated with being a public company, compliance with exchange listing and Securities and Exchange Commission (SEC) requirements, director and officer insurance premiums and investor relations costs. We also saw an increase in our stock-based compensation expense with the establishment of our new equity plan and related grants either in the form of restricted stock units or options. Our selling, general and administrative expenses may fluctuate from period to period due to the seasonality of our business and as we continue to add direct sales territory managers in new territories.
Interest Expense and Income
Interest expense consists primarily of interest expense related to our term loan facilities and convertible notes, including amortization of debt discount and issuance costs. Interest income is predominantly derived from investing surplus cash in money market funds and short-term marketable securities.
Other Income (Expense), Net
Other income (expense), net primarily consists of changes in the fair value of our derivative liabilities, changes in the fair value of our outstanding preferred stock warrants and foreign currency exchange gains and losses. In February 2020, the warrants were partly exercised and partly expired. The final fair value of the warrant liability was reclassified to stockholders’ (equity)/deficit. All of our derivative liabilities were settled during 2020. Upon the closing of our initial public offering on October 5, 2020, we paid $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC. In connection with the closing of the IPO, the 2020 Notes were converted into 2,561,484 shares of common stock.
125
Results of Operations:
Comparison of the Years Ended December 31, 2020 and December 31, 2019
The following table summarizes our results of operations for the period indicated:
| Year Ended December 31, | |||||||||||||||||||||||
| 2020 | 2019 | $ Change | % Change | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Revenue | $ | 32,733 | $ | 32,595 | $ | 138 | 0.4 | % | |||||||||||||||
| Costs of goods sold | 11,531 | 10,181 | 1,350 | 13.3 | % | ||||||||||||||||||
| Gross profit | 21,202 | 22,414 | (1,212) | (5.4) | % | ||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Research and development | 7,460 | 6,049 | 1,411 | 23.3 | % | ||||||||||||||||||
| Selling, general and administrative | 46,074 | 34,203 | 11,871 | 34.7 | % | ||||||||||||||||||
| Total operating expenses | 53,534 | 40,252 | 13,282 | 33.0 | % | ||||||||||||||||||
| Loss from operations | (32,332) | (17,838) | (14,494) | 81.3 | % | ||||||||||||||||||
| Interest income | 213 | 432 | (219) | (50.7) | % | ||||||||||||||||||
| Interest expense | (3,181) | (2,317) | (864) | 37.3 | % | ||||||||||||||||||
| Other income (expense), net | 3,282 | (617) | 3,899 | 631.9 | % | ||||||||||||||||||
| Net loss before tax | (32,018) | (20,340) | (11,678) | 57.4 | % | ||||||||||||||||||
| Income tax expense | 213 | 363 | (150) | (41.3) | % | ||||||||||||||||||
| Net loss | $ | (32,231) | $ | (20,703) | $ | (11,528) | 55.7 | % | |||||||||||||||
Revenue
Revenue increased by $0.1 million, or 0.4%, to $32.7 million during the year ended December 31, 2020, compared to $32.6 million during the year ended December 31, 2019. The increase in revenue was due to an increase in the sale of products in the United States of $5.5 million to $16.2 million during the year ended December 31, 2020, compared to $10.7 million during year ended December 31, 2019. The increase in United States revenue was driven by increased sales of the Zephyr Valve as we expanded commercialization efforts. The gains in the US were offset by a decrease in the sale of products due to lower procedure volumes in international markets of $5.4 million to $16.5 million during the year ended December 31, 2020, compared to $21.9 million during the year ended December 31, 2019. Revenue in both the United States and international markets were unfavorably impacted by the COVID-19 pandemic, which decreased and delayed procedures performed using our products for much of the second quarter of 2020 before beginning to recover in the second half of the year.
Cost of Goods Sold and Gross Margin
Cost of goods sold increased by $1.4 million, or 13.3%, to $11.5 million during the year ended December 31, 2020, compared to $10.2 million during the year ended December 31, 2019. The increase was mainly due to lower manufacturing utilization in the second quarter of 2020 resulting from the response to the COVID-19 pandemic combined with increased manufacturing costs as we expanded headcount and invested in operational infrastructure to support anticipated future growth. The increase in cost of goods sold caused gross margin to decrease from 69% during the year ended December 31, 2019 to 65% during the year ended December 31, 2020.
Research and Development Expenses
Research and development expenses increased by $1.4 million, or 23.3%, to $7.5 million during the year ended December 31, 2020, compared to $6.0 million during the year ended December 31, 2019. The increase in research
126
and development expenses was primarily due to an increase of $1.2 million in personnel expenses including stock based compensation as we expanded our research and development team and $0.4 million of professional services and other expenses, offset by a $0.2 million decrease in costs associated with our clinical trials, including fees paid to contract research organizations due to reduced clinical trial activity during the year ended December 31, 2020.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $11.9 million, or 34.7%, to $46.1 million during the year ended December 31, compared to $34.2 million during the year ended December 31, 2019. This increase in selling, general and administrative expenses was primarily due to an increase of $3.0 million resulting from the write-off of deferred initial public offering costs in the second quarter of 2020, $5.6 million of payroll and personnel-related expenses including stock based compensation as we expanded our sales and marketing function, an increase of $2.6 million of payroll and personnel-related expenses including stock based compensation for our administrative personnel due to increased headcount, an increase of $0.9 million in advertising expenses, an increase of $0.7 million in insurance costs associated with being a public company, and an increase of $1.0 million in facility and other expenses. These increases were offset by a decrease of $1.9 million in global travel and conference related expenses which were impacted by the COVID-19 pandemic.
Interest Expense and Income
Interest expense increased by $0.9 million, or 37.3%, to $3.2 million during the year ended December 31, 2020, compared to $2.3 million during the year ended December 31, 2019 primarily due to an increase in borrowings under the CIBC Term Loan and the 2020 Notes partially offset by the repayment of the Oxford Term Loan. Interest income decreased by $0.2 million for the year ended December 31, 2020 compared to the year ended December 31, 2019, which was primarily due to decreased marketable securities balances throughout most of the year.
Other Income (Expense), Net
Other income (expense), net increased by $3.9 million to $3.3 million during the year ended December 31, 2020, compared to ($0.6) million during the year ended December 31, 2019, primarily attributable to the closing of our IPO leading to favorable fair value adjustments of derivative liabilities.
127
Comparison of the Years Ended December 31, 2019 and December 31, 2018
The following table summarizes our results of operations for the period indicated:
| Years Ended December 31, | |||||||||||||||||||||||
| 2019 | 2018 | $ Change | % Change | ||||||||||||||||||||
| (in thousands) | |||||||||||||||||||||||
| Revenue | $ | 32,595 | $ | 20,004 | $ | 12,591 | 62.9 | % | |||||||||||||||
| Costs of goods sold | 10,181 | 7,718 | 2,463 | 31.9 | % | ||||||||||||||||||
| Gross profit | 22,414 | 12,286 | 10,128 | 82.4 | % | ||||||||||||||||||
| Operating expenses: | |||||||||||||||||||||||
| Research and development | 6,049 | 6,991 | (942) | (13.5) | % | ||||||||||||||||||
| Selling, general and administrative | 34,203 | 20,347 | 13,856 | 68.1 | % | ||||||||||||||||||
| Total operating expenses | 40,252 | 27,338 | 12,914 | 47.2 | % | ||||||||||||||||||
| Loss from operations | (17,838) | (15,052) | (2,786) | 18.5 | % | ||||||||||||||||||
| Interest income | 432 | 21 | 411 | — | |||||||||||||||||||
| Interest expense | (2,317) | (2,520) | 203 | (8.1) | % | ||||||||||||||||||
| Other income (expense), net | (617) | (916) | 299 | (32.6) | % | ||||||||||||||||||
| Net loss before tax | (20,340) | (18,467) | (1,873) | 10.1 | % | ||||||||||||||||||
| Income tax expense | 363 | 12 | 351 | — | |||||||||||||||||||
| Net loss | $ | (20,703) | $ | (18,479) | $ | (2,224) | 12.0 | % | |||||||||||||||
Revenue
Revenue increased by $12.6 million, or 62.9%, to $32.6 million during the year ended December 31, 2019, compared to $20.0 million during the year ended December 31, 2018. The increase in revenue was due to an increase in the sale of products in the United States by $10.1 million from $0.6 million for the year ended December 31, 2018 to $10.7 million for the year ended December 31, 2019 and an increase in the sale of products in international markets by $2.5 million from $19.4 million for the year ended December 31, 2018 to $21.9 million for the year ended December 31, 2019. We obtained FDA approval for the Zephyr Valves in the United States in June 2018 and began generating revenue in the United States in the third quarter of 2018. Overall, there was an increase in the number of units of products sold for the year ended December 31, 2019 as compared to the year ended December 31, 2018. Unit growth paralleled the growth in revenue dollars for 2019 while average selling prices maintained their 2018 levels showing a small improvement.
Cost of Goods Sold and Gross Margin
Cost of goods sold increased by $2.5 million, or 31.9%, to $10.2 million during the year ended December 31, 2019, compared to $7.7 million during the year ended December 31, 2018. The increase was primarily due to growth in sales volume and additional manufacturing overhead costs as we invested in our operational infrastructure to support anticipated future growth. Our gross margin increased from 61.4% for the year ended December 31, 2018 to 68.8% for the year ended December 31, 2019. The increase in gross margin was primarily due to lower fixed costs per unit from the increased sales volume of our products.
Research and Development Expenses
Research and development expenses decreased by $0.9 million, or 13.5%, to $6.0 million during the year ended December 31, 2019, compared to $7.0 million during the year ended December 31, 2018. The decrease in research and development expenses was primarily due to a decrease of $0.7 million of costs associated with our clinical trials,
128
including fees paid to contract research organizations (CROs) and consulting costs due to lower clinical trial activity during the year ended December 31, 2019.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased by $13.9 million, or 68.1%, to $34.2 million during the year ended December 31, 2019, compared to $20.3 million during the year ended December 31, 2018. This increase in selling, general and administrative expenses was primarily due to an increase of $8.8 million of payroll and personnel-related expenses for our sales personnel, an increase of $1.0 million of payroll and personnel-related expenses for our administrative personnel, an increase of $2.0 million of professional fees for legal, consulting, accounting, tax and other services, an increase of $1.2 million of travel related expenses and $0.4 million of advertising and marketing materials.
Interest Expense and Income
Interest expense decreased by $0.2 million, or 8.1%, to $2.3 million during the year ended December 31, 2019, compared to $2.5 million during the year ended December 31, 2018 primarily due to lower interest on convertible note payable to a related party because our convertible debt from Boston Scientific Corporation (BSC) converted into shares of our Series G-1 preferred stock in April 2019. Interest income increased by $0.4 million from the year ended December 31, 2018 to the year ended December 31, 2019 primarily due to interest income on proceeds from issuance of Series G-1 preferred stock invested in cash equivalents and short-term marketable securities.
Other Income (Expense), Net
Other income (expense), net decreased by $0.3 million, or 32.6%, to $0.6 million during the year ended December 31, 2019, compared to $0.9 million during the year ended December 31, 2018, primarily due to lower net foreign exchange losses of $0.1 million.
Liquidity and Capital Resources; Plan of Operation
To date, we have financed our operations primarily through private placements of equity securities, debt financing arrangements and sales of our products. As of December 31, 2020, we had cash and cash equivalents of $231.6 million, an accumulated deficit of $242.7 million, and $16.8 million outstanding under the CIBC Term Loan, net of debt discount.
Oxford Term Loan
From August 2014 until February 2020, we were party to a Loan and Security Agreement with Oxford (Oxford Agreement), which provided us with the ability to borrow up to $20.0 million in term loans. The Oxford Agreement included a floating interest rate tied to LIBOR and included customary representations and warranties, restrictive covenants, events of default and other customary terms and conditions. As of December 31, 2019, the Company was in default with a covenant in the Oxford Agreement resulting from its failure to maintain cash balances outside the United States within the levels set forth in the Oxford Agreement. This event of default was waived by Oxford. The loan was collateralized by a first-priority lien on substantially all of our assets, including cash and cash equivalents, accounts receivable, intellectual property and equipment.
In May 2017, we entered into an amendment to the Oxford Agreement, and in May 2018 we entered into two additional amendments. Each of the amendments extended the “interest only period” under the loan, during which the loan accrued interest, but were not required to make principal payments.
In connection with the closing of the Oxford Agreement in August 2014, we also entered into a Success Fee Agreement, which requires us to pay up to $2.5 million (the Success Fee) in the event of a sale or other disposition by us of all or substantially all of our assets, a merger or consolidation or an initial public offering (a Liquidity Event), in each case before August 28, 2021. We borrowed a total of $15.0 million principal amount of term loans
129
under the Oxford Agreement, which based on the formula in the Success Fee Agreement, obligated us to pay a Success Fee of $1.9 million on the closing of our IPO in October 2020.
In 2020, 2019 and 2018, we recorded interest expense on the term loan of $0.4 million, $1.7 million and $1.7 million, respectively.
We incurred fees and legal expenses of $0.1 million in connection with the Oxford Agreement and related Amendments, which were recorded as deferred financing costs and amortized to interest expense. We also paid $0.2 million in fees to Oxford which is reflected as a discount on the debt and was being accreted over the life of the term loan. In 2020, 2019 and 2018, we recorded interest expense related to deferred financing and debt issuance costs of less than $0.1 million, respectively.
In February 2020, we terminated and paid off in full $17.3 million, including the outstanding loan amount of $15.0 million, final payment of $1.3 million, amendment fees of $0.9 million and accrued interest of $0.1 million, outstanding under the Oxford Agreement. The repayment of the loans under the Oxford Agreement was accounted as extinguishment and the Company recorded a loss on debt extinguishment of $0.4 million. All of our obligations under the Oxford Agreement have been terminated except the indemnity obligation thereunder, which by their terms survive the facility. On October 5, 2020, upon the closing of our IPO, we paid $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC.
Loan and Security Agreement with Boston Scientific Corp (BSC)
From May 2017 until January 2020, we were party to a Second Lien Loan and Security Agreement with Boston Scientific Corp (BSC Agreement), which provided us with the ability to borrow up to $30.0 million in term loans. The BSC Agreement included a fixed interest rate of 8.96% and included customary representations and warranties, restrictive covenants, events of default and other customary terms and conditions.
The BSC Agreement provided for principal and accrued interest on the loans to convert into our stock at BSC’s option upon completion by us of any Qualified Equity or Debt Financing, or the occurrence of any Change of Control or Liquidation (each term as defined in the BSC Agreement).
In conjunction with the BSC Agreement, we and BSC entered into a No Shop Agreement such that from the date of execution of the agreement through the earlier of ten days following receipt by BSC of a letter confirming our submission of the final module of our PMA application to the FDA and March 31, 2018, we would not sign a term sheet or engage in discussions to sell our company. The No Shop Agreement terminated in 2018.
In addition, BSC’s Right of First Negotiation, originally received as part of BSC’s investment in our Series F-1 Preferred Stock, was amended to shorten the period it has to exercise its Right of First Negotiation from ten to five business days, and to shorten the exclusive negotiation period from 75 to 45 days with respect to the initial notice from us that we intend to pursue a change in control or an initial public offering. For subsequent notices from us, BSC has ten days to exercise its right of first negotiation, and 75 days to enter into definitive agreements for a change in control transaction. We provided an initial notice to BSC of our intention to pursue our initial public offering and BSC declined to exercise its Right of First Negotiation. BSC’s Right of First Negotiation terminated in connection with the closing of our IPO in October 2020.
We borrowed $6.0 million in 2017, $12.0 million in 2018 and $6.0 million in January 2019 under the BSC Agreement.
We incurred fees and legal expenses of $0.1 million in connection with the BSC Agreement, which are reported on the balance sheet as a direct deduction from the face amount of the convertible note. Amortization of the issuance costs are calculated using the effective interest rate method over the term of the note and recorded as a non-cash interest expense. In 2018, we recorded interest expense of $0.8 million.
130
In April 2019, all outstanding indebtedness and accrued interest under the BSC Agreement converted into shares of our Series G-1 preferred stock. At December 31, 2019, we retained the ability to draw up to an additional $6.0 million under the BSC Agreement until the maturity date in May 2022. We terminated the BSC Agreement in January 2020, which terminated all of our obligations under the BSC Agreement except the indemnity obligation thereunder, which by their terms survive the facility.
CIBC Term Loan
On February 20, 2020, we executed a Loan and Security Agreement with Canadian Imperial Bank of Commerce (CIBC), which we subsequently amended on April 17, 2020 and December 28, 2020 (as amended, the CIBC Agreement). The CIBC Agreement provided us with the ability to borrow up to $32.0 million in debt financing consisting of $17.0 million advanced at the closing of the agreement (Tranche A), with the option to draw up to an additional $8.0 million (Tranche B) on or before February 20, 2022 and an additional $7.0 million (Tranche C) on or before February 20, 2022. Tranche B is conditioned upon achieving a trailing six-month revenue of at least $15.0 million as of the date of any Tranche B Borrowing, and Tranche C is conditioned upon achieving a trailing six-month revenue of at least $20.0 million as of the date of any Tranche C borrowing. The availability of Tranche B and Tranche C is further conditioned upon the joining of Pulmonx International Sàrl to the CIBC Agreement and the execution by Pulmonx International Sàrl of Swiss-law collateral documentation in favor of CIBC.
The loan will mature on March 15, 2022. However, the loan’s maturity will automatically be extended to February 20, 2025 if we amend the 2020 Notes such that the 2020 Notes mature on May 21, 2025 or later or if all of the convertible notes are converted to preferred stock, in each case prior to March 1, 2022 and if no event of default exists under the CIBC Agreement. If the loan’s maturity is extended to 2025, equal monthly principal payments will begin after a 24-month interest only grace period. The interest only grace period can extend to 36 months if we achieve three-month trailing revenue of at least $20.0 million as of February 20, 2022.
The loan bears interest at a floating rate equal to 1.0% above the Wall Street Journal Prime Rate at any time. The Tranche C loan will bear interest at a floating rate equal to 1.5% above the Wall Street Journal Prime Rate at any time. The loan is collateralized by substantially all of our assets, including cash and cash equivalents, accounts receivable, intellectual property and equipment. We may prepay the loan, subject to certain requirements. The CIBC Agreement includes customary restrictive covenants, financial covenants, events of default and other customary terms and conditions. In December 2020, to address certain post-close covenants for which we were not in compliance, we entered into a Second Amendment to the CIBC Agreement that extended the compliance date for certain post-close covenants to June 30, 2021.
We paid $0.3 million fees to the lender and third parties which is reflected as a discount on the CIBC Loan and is being accreted over the life of the term loan using the effective interest method. During the year ended December 31, 2020, we recorded interest expense related to debt discount and debt issuance costs of CIBC Loan of $0.1 million.
Interest expense on the CIBC Loan amounted $0.7 million during the year ended December 31, 2020.
2020 Notes
In April 2020, we issued and sold the 2020 Notes in the aggregate principal amount of $33.0 million. We have the option to call up to an additional $33.0 million for a maximum aggregate amount of $66.0 million, subject to customary closing conditions, provided that any such call be for no less than $5.0 million on or prior to April 17, 2022. The 2020 Notes accrue interest at a rate equal to 2.0% above the Wall Street Journal Prime Rate. All unpaid interest and principal will be due and payable upon request of the majority of lenders (Majority Holders) on or after the earlier of April 17, 2022 or an event of default. The Company may prepay the 2020 Notes prior to April 17, 2022 only with the consent of the Majority Holders.
Upon an initial public offering which results in net proceeds of not less than $30.0 million (a Qualified IPO), the outstanding 2020 Notes and any unpaid accrued interest shall automatically convert in whole into shares of our common stock at a conversion price equal to the lesser of (i) price per share paid for common stock in the Qualified
131
IPO multiplied by either 85% if the conversion takes place within 18 months of the Initial Closing, or 80% otherwise, and (ii) $13.20 per share.
At any other time upon the election of the Majority Holders or a Significant Holder, the outstanding principal amount of the 2020 Notes and any unpaid accrued interest will convert in whole into our Series G-1 preferred stock at the Series G-1 conversion price of $13.20 per share. If there is an event of default prior to selection of such option, the 2020 Notes will be converted at a conversion price equal to the Series G-1 preferred stock conversion price of $13.20 per share multiplied by 75%.
Upon any event of default, the Majority Holders can, by providing us with a written notice, declare the principal and unpaid accrued interest under the 2020 Notes immediately due and payable.
The 2020 Notes include embedded derivatives that are required to be bifurcated from the 2020 Notes and accounted for separately as a single, compound embedded derivative instrument under ASC 815, Derivatives (2020 Notes derivative liability). We determined that the share settled redemption in the case of a financing or an IPO discussed above represents an embedded derivative that is not clearly and closely related to the debt host and have accounted for these settlement alternatives as separate embedded derivative liability. The fair value of the 2020 derivative liability of $3.9 million was recorded on the issuance date of the 2020 Notes resulting in a debt discount, which is reported as a direct deduction from the face amount of the 2020 Notes. The 2020 derivative liability is remeasured to its fair value at the end of each reporting period and any change in fair value is recognized in other income (expense), net in the statements of operations and comprehensive loss. The fair value of the 2020 derivative liability upon the effectiveness of the IPO was recognized in the consolidated statements of operations and comprehensive loss and the derivative liability was extinguished.
We incurred debt issuance costs of $0.1 million in connection with the 2020 Notes Agreement, which are reported on the balance sheet as a direct deduction from the face amount of the 2020 Notes.
Debt discount of $4.0 million is being amortized using the effective interest rate method over the term of the note and recorded as a non-cash interest expense.
During the year ended December 31, 2020, we recorded interest expense of $1.6 million on the 2020 Notes.
Our obligations with respect to the 2020 Notes are unsecured and subordinated to our obligations with respect to the CIBC Loan. The 2020 Notes include customary events of default.
Upon the closing of our IPO in October 2020, the 2020 Notes, including accrued interest thereon, automatically converted into 2,561,484 shares of our common stock at a conversion price of $13.20 per share.
Credit Agreement
In April 2020, Pulmonx International Sàrl, our wholly-owned subsidiary, entered into a COVID-19 Credit Agreement with UBS Switzerland AG to receive up to 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under Swiss Federal Government program to mitigate the economic impact of the spread of the coronavirus. In May 2020, Pulmonx International Sàrl received 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under the COVID-19 Credit Agreement. The COVID-19 Credit Agreement will bear no interest and is payable within 60 months after receipt of funds. As of December 31, 2020, Pulmonx International Sàrl did not make any repayment of credit agreement.
Paycheck Protection Program
On April 16, 2020, the Company received $2.7 million in support from the Paycheck Protection Program (the “PPP”) established by the U.S. federal government as part of the CARES Act for the PPP. Because the U.S. government subsequently changed its position and guidelines related to the PPP and publicly traded companies, the Company repaid the loan on May 1, 2020.
132
Funding Requirements
We expect to incur continued expenditures in the future in support of our commercial infrastructure, sales force and other commercialization efforts. In addition, we intend to continue to make investments in the development of our products, including ongoing research and development programs. We also expect to incur additional costs associated with operating as a public company. Lastly, we may also undertake additional expenses to further expand our commercial organization and efforts, enhance our research and development efforts and pursue product expansion opportunities.
As of December 31, 2020, we had cash and cash equivalents of $231.6 million. Based on our current planned operations, we expect that our cash and cash equivalents will enable us to fund our operating expenses for at least 12 months from the issuance of our financial statements as of and for the year ended December 31, 2020. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect.
Because of the numerous risks and uncertainties associated with research, development and commercialization of medical devices, we are unable to estimate the exact amount of our working capital requirements. Our future funding requirements will depend on many factors, including:
•the costs of commercialization activities related to commercializing our products in the United States and elsewhere, including expanding territories, increasing sales and marketing personnel, actual and anticipated product sales, marketing programs, manufacturing and distribution costs;
•the impact of the COVID-19 pandemic on our business;
•the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights;
•the research and development activities we intend to undertake, product enhancements that we intend to pursue;
•whether or not we pursue acquisitions or investments in businesses, products or technologies that are complementary to our current business;
•the degree and rate of market acceptance of our products in the United States and elsewhere;
•changes or fluctuations in our inventory supply needs and forecasts of our supply needs;
•our need to implement additional infrastructure and internal systems;
•our ability to hire additional personnel to support our operations as a public company; and
•the emergence of competing technologies or other adverse market developments.
Until such time, if ever, as we can generate product revenue sufficient to achieve profitability, we expect to finance our cash needs through a combination of public or private equity offerings, debt financings and collaborations or licensing arrangements. There can be no assurance that our efforts to procure additional financing will be successful or that, if they are successful, the terms and conditions of such financing will be favorable to us or our stockholders. If we do raise additional capital through public or private equity or convertible debt offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional capital through collaborations agreements, licensing arrangements or marketing and distribution arrangements, we may have to relinquish valuable
133
rights to our technologies, future revenue streams, research programs or product candidates or grant licenses that may not be favorable to us. If we are unable to raise capital when needed, we will need to delay, limit, reduce or terminate planned commercialization or product development activities, or grant rights to develop and commercialize products or product candidates that we would otherwise prefer to develop and market ourselves in order to reduce costs.
Summary Statement of Cash Flows
The following table sets forth the primary sources and uses of cash and cash equivalents for the period presented below:
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| (in thousands) | (in thousands) | ||||||||||||||||
| Net cash (used in) provided by: | |||||||||||||||||
| Operating activities | $ | (30,633) | $ | (20,765) | $ | (18,394) | |||||||||||
| Investing activities | 12,694 | (14,233) | 200 | ||||||||||||||
| Financing activities | 234,831 | 45,619 | 12,114 | ||||||||||||||
| Effect of exchange rate changes on cash and cash equivalents | 133 | 22 | 154 | ||||||||||||||
| Net increase (decrease) in cash, cash equivalents and restricted cash | $ | 217,025 | $ | 10,643 | $ | (5,926) | |||||||||||
Cash Flows from Operating Activities
Net cash used in operating activities was $30.6 million for the year ended December 31, 2020. Cash used in operating activities was primarily a result of the net loss of $32.2 million, an increase in inventory of $5.0 million primarily due to higher inventory levels required to support projected increase in sales, an increase in prepaid and other current assets of $1.8 million, a decrease in income taxes payable of $0.2 million, a decrease in lease liabilities of $0.9 million, and a non-cash credit resulting from the change in the fair value of derivative liabilities of $3.2 million due to extinguishment of derivative liability upon IPO partially offset by a decrease in accounts receivable of $1.5 million, an increase in accrued liabilities of $1.0 million, an increase in accounts payable of $0.6 million, stock based compensation expense of $3.2 million, write-down of inventory due to obsolescence of $0.5 million, depreciation and amortization expense of $0.5 million, amortization of debt discount and debt issuance costs of $1.0 million, non-cash lease expense of $1.5 million and non-cash charges for write-off of deferred offering costs of $3.0 million as we withdrew our registration statement for our initial public offering in May 2020. The increase in prepaid expenses, accrued liabilities and accounts payable is primarily due to increases in inventory and expenses related to operating as a public company and timing of payments to our vendors.
Net cash used in operating activities was $20.8 million for the year ended December 31, 2019. Cash used in operating activities was primarily a result of the net loss of $20.7 million, an increase in accounts receivable of $2.5 million primarily due an increase in sales, an increase in inventory of $2.6 million primarily due to higher inventory levels required to support higher sales and projected increase in sales and an increase in prepaid and other current assets of $0.7 million partially offset by, an increase in accrued liabilities of $3.4 million, an increase in accounts payable of $0.5 million, a change in the fair value of the derivative liability of $0.5 million, depreciation and amortization expense of $0.4 million, stock-based compensation expense of $0.4 million and a write down of inventory due to obsolescence of $0.3 million. The increases in prepaid expenses and other current assets, accrued liabilities and accounts payable is primarily due to increases in inventory, an increase in manufacturing, selling, general and administrative expenses and timing of payments to our vendors.
Net cash used in operating activities was $18.4 million for the year ended December 31, 2018. Cash used in operating activities was primarily a result of the net loss of $18.5 million, an increase in accounts receivable of $0.3 million due to an increase in sales, an increase in inventory of $1.2 million to support projected increases in sales, a
134
decrease in accounts payable of $0.6 million due to timing of payments to vendors, a decrease in deferred tax liability of $0.2 million, a decrease of $0.1 million in deferred rent liability partially offset by, an increase in accrued liabilities of $0.9 million due to timing of payments to vendors, change in the fair value of the derivative liability of $0.6 million, depreciation and amortization expense of $0.3 million, stock-based compensation expense of $0.4 million and write down of inventory due to obsolescence of $0.3 million.
Cash Flows from Investing Activities
Net cash provided by investing activities for the year ended December 31, 2020 was $12.7 million primarily consisting of maturities of short-term investments of $13.6 million offset by purchased of property and equipment of $0.9 million.
Net cash used in investing activities in the year ended December 31, 2019 was $14.2 million primarily consisting of purchases of short-term marketable securities of $21.5 million and purchases of property and equipment of $0.7 million offset by maturities of investments of $7.9 million.
Net cash provided by investing activities in the year ended December 31, 2018 was $0.2 million primarily consisting of maturities of investments of $0.5 million, offset by the purchases of property and equipment of $0.3 million.
Cash Flows from Financing Activities
Net cash provided by financing activities in the year ended December 31, 2020 of $234.8 million primarily relates to net proceeds from our initial public offering of $201.4 million, proceeds of $17.3 million from borrowing under the CIBC Agreement and COVID-19 Credit Agreement, net of lender fees and costs, proceeds of $33.0 million from the issuance of 2020 Notes, net of lender fees and costs, proceeds of $2.3 million from the exercise of warrants for Series C-1 preferred stock, and $2.7 million proceeds from the exercise of stock options, partially offset by repayment of debt obligations of $17.2 million under the Oxford Agreement, payment of Success Fee of $1.9 million, payment of deferred offering costs of $2.5 million and payment of debt issuance cost of $0.2 million.
Net cash provided by financing activities in the year ended December 31, 2019 of $45.6 million primarily relates to proceeds of $6.0 million from the issuance of the convertible note to BSC, proceeds of $39.7 million from issuance of Series G-1 preferred stock, net of issuance costs and $0.5 million proceeds from the exercise of stock options offset by payment of deferred offering costs of $0.6 million.
Net cash provided by financing activities in the year ended December 31, 2018 of $12.1 million primarily relates to proceeds of $12.0 million from additional borrowings under the BSC Agreement and proceeds of $0.1 million from the exercise of stock options and preferred stock warrants.
Contractual Obligations and Commitments
The following table summarizes our contractual obligations as of December 31, 2020:
| Payments Due by Period (in thousands) | |||||||||||||||||||||||||||||
| Less than 1 year | 1-3 years | 3-5 years | More than 5 years | Total | |||||||||||||||||||||||||
Lease obligations(1) | $ | 2,769 | $ | 7,453 | $ | 1,007 | $ | — | $ | 11,229 | |||||||||||||||||||
Long-term debt obligations(2) | 723 | 17,146 | 564 | — | 18,433 | ||||||||||||||||||||||||
| $ | 3,492 | $ | 24,599 | $ | 1,571 | $ | — | $ | 29,662 | ||||||||||||||||||||
_______________
(1)We lease our laboratory and office facilities in Redwood City, California, which expires in July 2025, and Neuchâtel, Switzerland, which can be cancelled with 12 months notice. In April 2020, we executed a sublease for another office facility in Redwood City, California for a three-year term commencing on June 1, 2020. The lease agreement provides for early termination if the Company or Sublandlord elects to terminate the lease, which may only occur on or after the expiration of the 18th full calendar month of the sublease term. The lease term for this lease is 18 months as it is not reasonably certain that we will not exercise early termination option. In September 2020, we amended a
135
sublease agreement entered in April 2020, to include additional facility space in Redwood City, California for a four-year term. The sublease agreement can be extended for an additional twelve month period, at our option. The lease term for this lease is 4 years as it is not reasonably certain that we will exercise the renewal option. The amendment also changed the lease term of sublease agreement entered in April 2020, which was extended until May 31, 2024, but left the early termination clause unchanged.
(2)In February 2020, we received $17.0 million gross proceeds from the CIBC Loan. In April 2020, we received $33.0 million in gross proceeds from the issuance of the 2020 Notes. We have the option to draw up to an additional $33.0 million of 2020 Notes, provided that any such draw be for no less than $5.0 million on or prior to April 17, 2022. Upon the closing of our IPO in October 2020, the 2020 Notes, including accrued interest thereon, automatically converted into 2,561,484 shares of our common stock at a conversion price of $13.20 per share. In May 2020, Pulmonx International Sàrl, our wholly-owned subsidiary, received 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under the COVID-19 Credit Agreement. The COVID-19 Credit Agreement bears no interest and is payable within 60 months after receipt of funds.
We enter into contracts in the normal course of business with third-party contract organizations for pre-clinical studies and testing, manufacture and supply of our pre-clinical materials and providing other services and products for operating purposes. These contracts generally provide for termination following a certain period after notice, and therefore we believe that our non-cancelable obligations under these agreements are not material.
Critical Accounting Policies, Significant Judgments and Use of Estimates
Our financial statements have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses incurred during the reporting periods. Our estimates are based on our knowledge of current events and actions we may undertake in the future and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may materially differ from these estimates under different assumptions or conditions. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. For more detail on our critical accounting policies, refer to Note 2 to the financial statements appearing elsewhere in this Annual Report on Form 10-K.
Revenue Recognition
Our revenue is generated from the sale of our products to distributors and hospitals in the U.S. and international markets. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring the products. Revenue is recognized when obligations under the terms of a contract with customers are satisfied, which occurs with the transfer of control of our products to our customers, either upon shipment of the product or delivery of the products to the customer under the terms and conditions agreed with the customer. We defer revenue relating to any remaining performance obligations by us to the customer after delivery, such as free products and free analysis services of patient scans to determine suitability of the patients for the treatment using the Zephyr Valves.
We identify performance obligations in contracts with customers, which may include our products and implied promises to provide free products and analysis services for patient scans. The transaction price is determined based on the amount expected to be entitled to in exchange for transferring the promised services or product to the customer. We are entitled to the total consideration for the products ordered by customers, net of early pay discounts, volume-based rebates and other transaction price adjustments. We exclude taxes assessed by governmental authorities on revenue-producing transactions from the measurement of the transaction price. We accept product returns at our discretion or if the product is defective as manufactured. We elected to treat shipping and handling costs as a fulfillment cost and include them in the cost of goods sold as incurred.
Inventories
Inventories are valued at the lower of cost to purchase or manufacture the inventory or net realizable value. Cost is determined using the first-in, first-out method for all inventories. Net realizable value is determined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. We record write-downs of inventories which are obsolete or in excess of anticipated demand or
136
market value based on consideration of product lifecycle stage, technology trends, product development plans and assumptions about future demand and market conditions. Inventory write-downs are intended to reduce the carrying value of inventory to its net realizable value.
Research and Development
Research and development expenses consist of costs incurred to further our research and development activities and include compensation costs, stock-based compensation, engineering and research expenses, clinical trials and related expenses, regulatory expenses, manufacturing expenses incurred to build products for testing, allocated facilities costs, consulting fees and other expenses incurred to sustain our overall research and development programs. All research and development costs are expensed as incurred.
Clinical trial costs are a significant component of our research and development expenses. We have a history of contracting with third parties that perform various clinical trial activities on our behalf in the ongoing development of our product candidates. The financial terms of these contracts are subject to negotiations and may vary from contract to contract and may result in uneven payment flow. We accrue and expense costs of our clinical trial activities performed by third parties, including CROs and other service providers, based upon estimates of the work completed over the life of the individual study in accordance with associated agreements. We determine these estimates through discussion with internal personnel and outside service providers as to progress or stage of completion of trials or services pursuant to contracts with clinical research organizations and other service providers and the agreed-upon fee to be paid for such services.
Preferred Stock
We record all shares of preferred stock at their respective fair values on the dates of issuance, net of issuance costs. Our preferred stock is recorded outside of permanent equity because while it is not mandatorily redeemable, in certain events considered not solely within our control, such as a merger, acquisition or sale of all or substantially all of our assets, each of which we refer to as a deemed liquidation event, our preferred stock will become redeemable at the option of the holders of at least a majority of the then outstanding such shares. We have not adjusted the carrying values of the preferred stock to its liquidation preference because a deemed liquidation event obligating us to pay the liquidation preferences to holders of shares of preferred stock is not probable. Subsequent adjustments to the carrying values to the liquidation preferences will be made only when it becomes probable that such a deemed liquidation event will occur.
Preferred Stock Warrants
We have issued freestanding warrants to purchase shares of preferred stock. We accounted for these warrants as a liability in our financial statements because the underlying instrument into which the warrants are exercisable contains deemed liquidation provisions that are outside our control. The warrants were recorded at fair value using an option pricing model based on an allocation of our aggregate value to the outstanding equity instruments, applying a discount to the warrant value for lack of marketability. The warrants were subject to remeasurement at each balance sheet date with any changes in fair value being recognized as a component of other income (expense), net in the statements of operations and comprehensive loss. We continued to adjust the liability for changes in fair value until the exercise or expiration of the preferred stock warrants in February 2020 (see Note 9 to our consolidated financial statements) at which time the related final fair value of the warrant liability was reclassified to stockholders’ equity (deficit).
Derivative Instruments
In connection with the Oxford Agreement, we entered into the Success Fee Agreement. In the event of a sale or other disposition by the Company of all or substantially all of its assets, a merger or consolidation, or an initial public offering (a Liquidity Event), before the termination of the agreement on August 28, 2021, we are required to pay up to $2.5 million to Oxford Finance LLC. The Success Fee is equal to 6.25% of the term loan if the Liquidity Event occurs within 18 months of August 28, 2014, 8.75% if the Liquidity Event occurs after 18 months and within
137
3 years of August 28, 2014, and 12.50% if the Liquidity Event occurs after the third anniversary of August 28, 2014. As of December 31, 2019, the maximum amount of Success Fee subject to a potential payout was $1.9 million. This agreement has been identified as a freestanding derivative under ASC 815, Derivatives (“Success Fee”) and is remeasured to its fair value at the end of each reporting period and any change in fair value is recognized as change in other income (expense), net in the statements of operations and comprehensive loss (see Note 4 to our consolidated financial statements).
We valued the Success Fee derivative liability based on the Success Fee amount of $1.9 million and the probability and estimated timing of a Liquidity Event. On October 5, 2020, in connection with the IPO, we paid $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC.
The 2020 Notes include embedded derivatives that are required to be bifurcated from the 2020 Notes and accounted for separately as a single, compound embedded derivative instrument under ASC 815, Derivatives (2020 Notes derivative liability). We determined that the share settled redemption in the case of a financing or an IPO represents an embedded derivative that is not clearly and closely related to the debt host and have accounted for these settlement alternatives as separate embedded derivative liability. The fair value of the 2020 derivative liability of $3.9 million was recorded on the issuance date of the 2020 Notes resulting in a debt discount, which is reported as a direct deduction from the face amount of the 2020 Notes. The 2020 derivative liability is remeasured to its fair value at the end of each reporting period and any change in fair value is recognized in other income (expense), net in the statements of operations and comprehensive loss.
We valued the 2020 Notes derivative liability using the “with and without” methodology. The “with and without” methodology involves valuing the convertible note on an as is basis and then valuing the 2020 Notes without each individual embedded derivative. The difference between the value of the 2020 Notes with the embedded derivatives and the value without each individual embedded derivative equals the fair value of that embedded derivative. We used a Monte Carlo Simulation (“MCS”) to value the embedded derivatives. The first step of each simulation was to forecast our Series G-1 preferred stock price through the expiration of the 2020 Notes. In order to estimate the future share price of the Series G-1 preferred stock, we applied a “random walk” model based upon a Geometric Brownian Motion process with a constant drift.
The fair value of the 2020 Notes derivative liability was determined using the following assumptions:
| April 17 | |||||
| 2020 | |||||
| Risk-free interest rate | 0.2 | % | |||
| Current Series G-1 convertible preferred stock value per share | $ | 0.84 | |||
| Series G-1 convertible preferred stock volatility | 34.4 | % | |||
Upon the closing of the IPO in October 2020, the 2020 Notes converted pursuant to a qualified initial public offering. As a result, we concluded that the 2020 Notes derivative had no value upon the closing of the IPO, because value of the notes with and without such derivative was the same.
Common Stock Valuation and Stock-Based Compensation
We recognize compensation costs related to stock options granted to employees and non-employees based on the estimated fair value of the awards on the date of grant. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option pricing model. The grant date fair value of stock-based awards is expensed on a straight-line basis over the period during which the optionee is required to provide service in exchange for the award, which is typically the vesting period. We account for forfeitures as they occur.
Estimates of the fair value of equity awards as of the grant date using valuation models such as the Black-Scholes option pricing model are affected by assumptions with a number of complex variables. Changes in the assumptions can materially affect the fair value and ultimately the amount of stock-based compensation expense recognized.
138
These inputs are subjective and generally require significant analysis and judgment to develop. Changes in the following assumptions can materially affect the estimate of the fair value of stock-based compensation:
•Expected Term. The expected term is calculated using the simplified method, which is available where there is insufficient historical data about exercise patterns and post-vesting employment termination behavior. The simplified method is based on the vesting period and the contractual term for each grant, or for each vesting-tranche for awards with graded vesting. The mid-point between the vesting date and the maximum contractual expiration date is used as the expected term under this method. For awards with multiple vesting-tranches, the periods from grant until the mid-point for each of the tranches are averaged to provide an overall expected term.
•Expected Volatility. The expected volatility is derived from the average historical volatilities of publicly traded companies within our industry that we consider to be comparable to our business over a period approximately equal to the expected term for the options. In evaluating similarity, we considered factors such as stage of development, risk profile, enterprise value and position within the life sciences industry.
•Risk-free Interest Rate. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of the grant for zero-coupon U.S. Treasury notes with remaining terms similar to the expected term of the options.
•Dividend Rate. We assumed the expected dividend to be zero as we have never paid dividends and have no current plans to do so.
Common Stock Valuation
Prior to the Company’s IPO, the estimated fair value of the common stock underlying our stock options and stock awards was determined at each grant date by our board of directors, with input from management. All options to purchase shares of our common stock are intended to be exercisable at a price per share not less than the per-share fair value of our common stock underlying those options on the date of grant.
In the absence of a public trading market for our common stock, on each grant date, we develop an estimate of the fair value of our common stock based on the information known to us on the date of grant, upon a review of any recent events and their potential impact on the estimated fair value per share of the common stock, and in part on contemporaneous input from an independent third-party valuation firm.
Our valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation (Practice Aid).
The assumptions used to determine the estimated fair value of our common stock are based on numerous objective and subjective factors, combined with management judgment, including:
•external market conditions affecting the pharmaceutical and medical devices industry and trends within the industry;
•our stage of development and business strategy;
•the rights, preferences and privileges of our convertible preferred stock relative to those of our common stock;
•the prices at which we sold shares of our convertible preferred stock;
•our financial condition and operating results, including our levels of available capital resources;
139
•the progress of our research and development efforts;
•equity market conditions affecting comparable public companies; and
•general U.S. market conditions and the lack of marketability of our common stock.
For our valuations performed in August 2019, we applied the market approach outlined in the Practice Aid to determine our enterprise value. Specifically, we used the guideline public company analysis, which relies on an analysis of publicly traded companies similar in industry or business model to us and uses these guideline companies to develop relevant market multiples and ratios. These multiples and ratios were then applied to our corresponding financial metrics.
For our valuations performed in November 2019 and April 2020, we applied a weighted combination of the market approach and the income approach outlined in the Practice Aid to determine our enterprise value. Under the market approach, we used the guideline public company analysis, guideline transactions analysis and an analysis based on a recent acquisition offer. For the guideline public company and guideline transactions analysis, we identified a group of comparable public companies and recent transactions within our industry. For the comparable companies, we estimated market multiples and ratios. These multiples and ratios were then applied to our corresponding financial metrics. When selecting comparable companies, consideration was given to industry similarity, their specific products offered, financial data availability and capital structure. The income approach incorporates the use of a discounted cash flow model in which our estimated future cash flows and our residual value beyond the forecast period are discounted using an appropriately risk-adjusted weighted average cost of capital. Our forecasts used in the discounted cash flow model are based in part on strategic plans and represent our estimates based on current and forecasted business and market conditions.
The Practice Aid identifies various available methods for allocating enterprise value across classes and series of capital stock to determine the estimated fair value of common stock at each valuation date. In accordance with the Practice Aid, we considered the following methods:
•Option Pricing Method. Under the option pricing method (OPM), shares are valued by creating a series of call options with exercise prices based on the liquidation preferences and conversion terms of each equity class. The estimated fair values of the preferred and common stock are inferred by analyzing these options.
•Probability-Weighted Expected Return Method. The probability-weighted expected return method is a scenario-based analysis that estimates value per share based on the probability-weighted present value of expected future investment returns, considering each of the possible outcomes available to us, as well as the economic and control rights of each share class.
We determined that the OPM method was the most appropriate method for allocating our enterprise value to determine the estimated fair value of our common stock. In determining the estimated fair value of our common stock, our board of directors also considered the fact that our stockholders could not freely trade our common stock in the public markets. Accordingly, we applied discounts to reflect the lack of marketability of our common stock based on the weighted-average expected time to liquidity. The estimated fair value of our common stock at each grant date reflected a non-marketability discount partially based on the anticipated likelihood and timing of a future liquidity event.
As of December 31, 2020, there was $14.8 million of unrecognized compensation costs related to non-vested common stock options, expected to be recognized over a weighted-average period of 2.28 years. Subsequent to December 31, 2020, we granted options for 8,600 shares of common stock and 6,300 restricted stock units to employees, subject to service-based vesting conditions, which vest over a weighted-average period of 4 years. The options have a weighted-average exercise price of $62.34 per share.
Subsequent to the Company’s IPO, the fair value of the Company’s common stock is determined based on its closing market price.
140
Income Taxes
Our major tax jurisdictions are the United States and California, Switzerland and Neuchâtel, and Grand Cayman.
We provide for income taxes under the asset and liability method. Current income tax expense or benefit represents the amount of income taxes expected to be payable or refundable for the current year. Deferred income tax assets and liabilities arise due to differences between when assets or liabilities are recognized for tax purposes and when they are recognized for financial reporting purposes. Net operating losses and credit carryforwards are also deferred tax assets. Deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when such items are expected to reverse. Deferred income tax assets are reduced, as necessary, by a valuation allowance when management determines it is more likely than not that some or all of the tax benefits will not be realized.
We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. All of our tax years will remain open for examination by the federal and state tax authorities for three and four years, respectively, from the date of utilization of the net operating loss or research and development credits. We do not have any tax audits or other issues pending.
Utilization of the net operating loss carryforwards and research and development tax credit carryforwards may be subject to annual limitations due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended (Code), as defined in Section 382, and other similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization.
The 2017 Tax Cut and Jobs Act included the implementation of a modified territorial tax system, which has the effect of subjecting earnings of our foreign subsidiaries to U.S. taxation on Global Intangible Low-Taxed Income (GILTI). The FASB allows companies to adopt a policy election to account for the tax on GILTI under one of two methods: (i) account for the tax on GILTI as a component of tax expense in the period in which the tax is incurred (the period cost method) or (ii) account for the tax on GILTI in a company’s measurement of deferred taxes (the deferred method). We have elected to account for the tax on GILTI under the period cost method.
The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act enacted in March 2020 did not provide an income tax benefit for us given our historical U.S. losses and a full valuation allowance against our net U.S. deferred tax assets.
JOBS Act Accounting Election
The Jumpstart Our Business Startups Act of 2012 (JOBS Act) permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. However, we have chosen to irrevocably “opt out” of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies.
Recent Accounting Pronouncements
See “Recent Accounting Pronouncements” in Note 3 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Interest Rate Risk
We are exposed to interest rate risks related to our cash, cash equivalents and borrowings. We had cash and cash equivalents of $231.6 million as of December 31, 2020, which consist of cash and money market funds. We held
141
cash in foreign banks of approximately $5.6 million at December 31, 2020 that was not federally insured. Interest-earning money market funds carry a degree of interest rate risk; however, historical fluctuations in interest income have not been significant.
We had outstanding debt of $16.8 million under the CIBC Agreement with interest rate of 4.25% as of December 31, 2020. In the ordinary course of business, we may enter into contractual arrangements to reduce our exposure to interest rate risks. We believe that a 10% change in interest rates would not have a significant impact on our consolidated financial statements.
Foreign Currency Exchange Risk
We operate in countries other than the United States and are exposed to foreign currency risks. Revenue from sales outside of the United States represented 50.5%, 67.2% and 97.2% of our total revenue for the year ended December 31, 2020, 2019 and 2018, respectively. We bill most direct sales outside of the United States in local currencies, which are mostly comprised of the Swiss franc, the Euro, the British pound, and the Australian dollar. Operating expenses related to these sales are largely denominated in the same respective currency, thereby limiting our transaction risk exposure. We therefore believe that the risk of a significant impact on our operating income from foreign currency fluctuations is not significant. The risk of a significant impact on our operating income from foreign currency fluctuations will further diminish as revenue from sales to customers in the United States increases and represents a greater proportion of total revenues. A 10% change in weighted average foreign currency exchange rates would have changed our revenues and operating expenses for the year ended December 31, 2020 by approximately $1.6 million and $1.1 million, respectively, with a net impact of $0.5 million on our net income. We do not currently hedge our exposure to foreign currency exchange rate fluctuations; however, we may choose to hedge our exposure in the future.
142
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Pulmonx Corporation
INDEX TO THE FINANCIAL STATEMENTS
143
Report of Independent Registered Public Accounting Firm
Shareholders and Board of Directors
Pulmonx Corporation
Redwood City, California
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheets of Pulmonx Corporation (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive loss, convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the three years in the period ended December 31, 2020, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with accounting principles generally accepted in the United States of America.
Change in Accounting Principle
As discussed in Note 2 to the consolidated financial statements, the Company has changed its method of accounting for leases during 2019 due to the adoption of the Accounting Standards Codification Topic 842, “Leases.”
Basis for Opinion
These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion.
/s/ BDO USA, LLP
We have served as the Company's auditor since 2011.
San Jose, California
March 15, 2021
F-1
Pulmonx Corporation
Consolidated Balance Sheets
(in thousands, except share and per share amounts)
| December 31, 2020 | December 31, 2019 | ||||||||||
| Assets | |||||||||||
| Current assets | |||||||||||
| Cash and cash equivalents | $ | 231,561 | $ | 14,767 | |||||||
| Restricted cash | 231 | — | |||||||||
| Short-term marketable securities | — | 13,580 | |||||||||
| Accounts receivable, net | 4,228 | 5,511 | |||||||||
| Inventory | 10,741 | 5,612 | |||||||||
| Prepaid expenses and other current assets | 3,228 | 1,601 | |||||||||
| Total current assets | 249,989 | 41,071 | |||||||||
| Property and equipment, net | 1,474 | 902 | |||||||||
| Goodwill | 2,333 | 2,333 | |||||||||
| Intangible assets, net | 400 | 524 | |||||||||
| Deferred offering costs | — | 1,563 | |||||||||
| Right of use assets | 8,976 | 6,561 | |||||||||
| Other long-term assets | 536 | 579 | |||||||||
| Total assets | $ | 263,708 | $ | 53,533 | |||||||
| Liabilities, Convertible Preferred Stock and Stockholders’ Equity (Deficit) | |||||||||||
| Current liabilities | |||||||||||
| Accounts payable | $ | 1,472 | $ | 2,681 | |||||||
| Accrued liabilities | 8,651 | 9,463 | |||||||||
| Income taxes payable | 94 | 233 | |||||||||
| Deferred revenue | 71 | 173 | |||||||||
| Current lease liabilities | 2,238 | 446 | |||||||||
| Derivative liability | — | 1,165 | |||||||||
| Total current liabilities | 12,526 | 14,161 | |||||||||
| Deferred tax liability | 62 | 43 | |||||||||
| Long-term lease liabilities | 7,618 | 6,403 | |||||||||
| Credit agreement | 564 | — | |||||||||
| Term loan | 16,804 | 14,965 | |||||||||
| Total liabilities | 37,574 | 35,572 | |||||||||
| Commitments and contingencies (Note 7) | |||||||||||
Convertible preferred stock, $0.001 par value, no shares authorized as of December 31, 2020 and 177,985,811 shares authorized as of December 31, 2019; no shares issued and outstanding as of December 31, 2020 and 17,583,150 shares issued and outstanding as of December 31, 2019; liquidation value of $0 and $210,610 as of December 31, 2020 and December 31, 2019, respectively (Note 10) | — | 205,339 | |||||||||
| Stockholders’ equity (deficit) | |||||||||||
F-2
Preferred stock, $0.001 par value, 10,000,000 shares authorized as of December 31, 2020 and no shares authorized as of December 31, 2019; no shares issued and outstanding as of December 31, 2020 and December 31, 2019 | — | — | |||||||||
Common stock, $0.001 par value, 200,000,000 shares and 240,000,000 shares authorized as of December 31, 2020 and December 31, 2019; 35,693,753 and 2,100,203 shares issued and outstanding as of December 31, 2020 and December 31, 2019, respectively | 36 | 2 | |||||||||
| Additional paid-in capital | 467,147 | 21,750 | |||||||||
| Accumulated other comprehensive income | 1,685 | 1,373 | |||||||||
| Accumulated deficit | (242,734) | (210,503) | |||||||||
| Total stockholders’ equity (deficit) | 226,134 | (187,378) | |||||||||
| Total liabilities, convertible preferred stock and stockholders’ equity | $ | 263,708 | $ | 53,533 | |||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-3
Pulmonx Corporation
Consolidated Statements of Operations and Comprehensive Loss
(in thousands, except share and per share amounts)
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Revenue | $ | 32,733 | $ | 32,595 | $ | 20,004 | |||||||||||
| Cost of goods sold | 11,531 | 10,181 | 7,718 | ||||||||||||||
| Gross profit | 21,202 | 22,414 | 12,286 | ||||||||||||||
| Operating expenses | |||||||||||||||||
| Research and development | 7,460 | 6,049 | 6,991 | ||||||||||||||
| Selling, general and administrative | 46,074 | 34,203 | 20,347 | ||||||||||||||
| Total operating expenses | 53,534 | 40,252 | 27,338 | ||||||||||||||
| Loss from operations | (32,332) | (17,838) | (15,052) | ||||||||||||||
| Interest income | 213 | 432 | 21 | ||||||||||||||
| Interest expense | (3,181) | (2,317) | (2,520) | ||||||||||||||
| Other income (expense), net | 3,282 | (617) | (916) | ||||||||||||||
| Net loss before tax | (32,018) | (20,340) | (18,467) | ||||||||||||||
| Income tax expense | 213 | 363 | 12 | ||||||||||||||
| Net loss | (32,231) | (20,703) | (18,479) | ||||||||||||||
| Other comprehensive income (loss) | |||||||||||||||||
| Currency translation adjustment | 318 | 34 | 126 | ||||||||||||||
| Change in unrealized (losses) gains on marketable securities | (6) | 6 | — | ||||||||||||||
| Total other comprehensive income | 312 | 40 | 126 | ||||||||||||||
| Comprehensive loss | $ | (31,919) | $ | (20,663) | $ | (18,353) | |||||||||||
| Net loss per share attributable to common stockholders, basic and diluted | $ | (3.16) | $ | (11.66) | $ | (11.03) | |||||||||||
Weighted-average shares used in computing net loss per share attributable to common stockholders, basic and diluted | 10,184,841 | 1,776,110 | 1,674,779 | ||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-4
Pulmonx Corporation
Consolidated Statements of Convertible Preferred Stock and Stockholders’ Equity (Deficit)
(in thousands, except share amounts)
| Convertible Preferred Stock | Common Stock | Additional Paid-In Capital | Accumulated Other Comprehensive Income | Accumulated Deficit | Total Stockholders’ Equity (Deficit) | ||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Shares | Amount | ||||||||||||||||||||||||||||||||||||||||||||
| Balances at January 1, 2018 | 12,641,035 | $ | 140,452 | 1,701,293 | $ | 2 | $ | 20,718 | $ | 1,207 | $ | (171,321) | $ | (149,394) | |||||||||||||||||||||||||||||||||
| Issuance of Series C-1 convertible preferred stock upon exercise of warrants | 7,884 | 83 | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Issuance of common stock upon exercise of stock options | — | — | 18,153 | — | 31 | — | — | 31 | |||||||||||||||||||||||||||||||||||||||
| Change in shares subject to repurchase | — | — | — | — | 24 | — | — | 24 | |||||||||||||||||||||||||||||||||||||||
| Stock-based compensation expense | — | — | — | — | 366 | — | — | 366 | |||||||||||||||||||||||||||||||||||||||
| Currency translation adjustment | — | — | — | — | — | 126 | — | 126 | |||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | (18,479) | (18,479) | |||||||||||||||||||||||||||||||||||||||
| Balances at December 31, 2018 | 12,648,919 | 140,535 | 1,719,446 | 2 | 21,139 | 1,333 | (189,800) | (167,326) | |||||||||||||||||||||||||||||||||||||||
Issuance of Series G-1 convertible preferred stock, net of issuance costs of $329 | 4,934,231 | 64,804 | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
Issuance of common stock upon exercise of stock options | — | — | 390,318 | — | 528 | — | — | 528 | |||||||||||||||||||||||||||||||||||||||
| Change in shares subject to repurchase | — | — | — | — | (281) | — | — | (281) | |||||||||||||||||||||||||||||||||||||||
| Repurchase of early exercised common stock options | — | — | (9,147) | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Common stock retired during the year for no consideration | — | — | (414) | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
Stock-based compensation expense | — | — | — | — | 364 | — | — | 364 | |||||||||||||||||||||||||||||||||||||||
| Currency translation adjustment | — | — | — | — | — | 34 | — | 34 | |||||||||||||||||||||||||||||||||||||||
| Change in unrealized gains on marketable securities | — | — | — | — | — | 6 | — | 6 | |||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | (20,703) | (20,703) | |||||||||||||||||||||||||||||||||||||||
| Balances at December 31, 2019 | 17,583,150 | 205,339 | 2,100,203 | 2 | 21,750 | 1,373 | (210,503) | (187,378) | |||||||||||||||||||||||||||||||||||||||
| Issuance of Series C-1 convertible preferred stock upon exercise of warrants | 213,876 | 2,260 | — | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Conversion of convertible preferred stock into common stock | (17,797,026) | (207,599) | 17,797,026 | 18 | 207,581 | — | — | 207,599 | |||||||||||||||||||||||||||||||||||||||
| Conversion of 2020 Notes into common stock | — | — | 2,561,484 | 3 | 30,589 | — | — | 30,592 | |||||||||||||||||||||||||||||||||||||||
Issuance of common stock upon initial public offering, net of issuance costs and underwriting discount of $17,108 | — | — | 11,500,000 | 11 | 201,381 | — | — | 201,392 | |||||||||||||||||||||||||||||||||||||||
| Issuance of common stock upon exercise of stock options | — | — | 1,745,040 | 2 | 2,703 | — | — | 2,705 | |||||||||||||||||||||||||||||||||||||||
| Repurchase of early exercised common stock options | — | — | (10,000) | — | — | — | — | — | |||||||||||||||||||||||||||||||||||||||
| Change in shares subject to repurchase | — | — | — | — | (346) | — | — | (346) | |||||||||||||||||||||||||||||||||||||||
F-5
| Stock-based compensation expense | — | — | — | — | 3,489 | — | — | 3,489 | |||||||||||||||||||||||||||||||||||||||
| Currency translation adjustment | — | — | — | — | — | 318 | — | 318 | |||||||||||||||||||||||||||||||||||||||
| Change in unrealized losses on marketable securities | — | — | — | — | — | (6) | — | (6) | |||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | — | — | — | (32,231) | (32,231) | |||||||||||||||||||||||||||||||||||||||
| Balances at December 31, 2020 | — | $ | — | 35,693,753 | $ | 36 | $ | 467,147 | $ | 1,685 | $ | (242,734) | $ | 226,134 | |||||||||||||||||||||||||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-6
Pulmonx Corporation
Consolidated Statements of Cash Flows
(in thousands)
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Cash flows from operating activities | |||||||||||||||||
| Net loss | $ | (32,231) | $ | (20,703) | $ | (18,479) | |||||||||||
| Adjustments to reconcile net loss to net cash used in operating activities | |||||||||||||||||
| Stock-based compensation expense | 3,197 | 364 | 366 | ||||||||||||||
| Change in fair value of convertible preferred stock warrant liability | — | (12) | 12 | ||||||||||||||
| Change in fair value of derivative liability | (3,190) | 523 | 642 | ||||||||||||||
| Allowance for doubtful accounts | (7) | (4) | (15) | ||||||||||||||
| Inventory write-downs | 472 | 332 | 297 | ||||||||||||||
| Depreciation and amortization expense | 483 | 365 | 270 | ||||||||||||||
| Amortization of debt discount and debt issuance costs | 968 | 28 | 36 | ||||||||||||||
| Write-off of deferred offering costs | 3,030 | — | — | ||||||||||||||
| Amortization of premiums and discounts on short-term marketable securities | (35) | (61) | — | ||||||||||||||
| Gain on extinguishment of convertible note | — | (32) | — | ||||||||||||||
| Non-cash lease expense | 1,467 | 836 | — | ||||||||||||||
| Net changes in operating assets and liabilities: | |||||||||||||||||
| Accounts receivable | 1,457 | (2,524) | (262) | ||||||||||||||
| Inventory | (5,047) | (2,613) | (1,245) | ||||||||||||||
| Prepaid expenses and other current assets | (1,756) | (684) | 21 | ||||||||||||||
| Other assets | 65 | 3 | 18 | ||||||||||||||
| Accounts payable | 592 | 524 | (648) | ||||||||||||||
| Accrued liabilities | 1,019 | 3,375 | 928 | ||||||||||||||
| Income taxes payable | (155) | 182 | (34) | ||||||||||||||
| Deferred rent | — | — | (62) | ||||||||||||||
| Lease liabilities | (876) | (692) | — | ||||||||||||||
| Deferred tax liability | 22 | (5) | (200) | ||||||||||||||
| Deferred revenue | (108) | 33 | (39) | ||||||||||||||
| Net cash used in operating activities | (30,633) | (20,765) | (18,394) | ||||||||||||||
| Cash flows from investing activities | |||||||||||||||||
| Purchases of investments | — | (21,450) | — | ||||||||||||||
| Maturities of investments | 13,605 | 7,937 | 500 | ||||||||||||||
| Purchases of property and equipment | (911) | (720) | (316) | ||||||||||||||
| Proceeds from sale of property and equipment | — | — | 16 | ||||||||||||||
| Net cash provided by (used in) investing activities | 12,694 | (14,233) | 200 | ||||||||||||||
| Cash flows from financing activities | |||||||||||||||||
| Proceeds from borrowing under term loans, net of payment of lender fees and costs | 17,291 | — | — | ||||||||||||||
| Repayment of term loans | (17,248) | — | — | ||||||||||||||
| Payment of Success Fee | (1,875) | — | — | ||||||||||||||
Proceeds from the issuance of convertible note, net of payment of lender fees and costs (includes $0, $6,000 and $12,000 from related party for the years ended December 31, 2020, 2019 and 2018, respectively) | 32,950 | 6,000 | 12,000 | ||||||||||||||
| Proceeds from Paycheck Protection Program loan | 2,666 | — | — | ||||||||||||||
| Repayment of Paycheck Protection Program loan | (2,666) | — | — | ||||||||||||||
| Debt issuance cost | (162) | — | — | ||||||||||||||
| Payments of deferred offering costs | (2,462) | (568) | — | ||||||||||||||
Proceeds from issuance of Series G-1 convertible preferred stock, net of issuance costs of $329 | — | 39,671 | — | ||||||||||||||
F-7
| Proceeds from exercise of warrants for Series C-1 convertible preferred stock | 2,261 | — | 83 | ||||||||||||||
| Proceeds from exercise of common stock options | 2,705 | 528 | 31 | ||||||||||||||
| Proceeds from initial public offering, net of offering costs | 201,392 | — | — | ||||||||||||||
| Payments for the repurchase of early exercised common stock options | (21) | (12) | — | ||||||||||||||
| Net cash provided by financing activities | 234,831 | 45,619 | 12,114 | ||||||||||||||
| Effect of exchange rate changes on cash and cash equivalents | 133 | 22 | 154 | ||||||||||||||
| Net (decrease) increase in cash and cash equivalents | 217,025 | 10,643 | (5,926) | ||||||||||||||
| Cash and cash equivalents at beginning of year | 14,767 | 4,124 | 10,050 | ||||||||||||||
| Cash, cash equivalents and restricted cash at end of year | $ | 231,792 | $ | 14,767 | $ | 4,124 | |||||||||||
| Reconciliation of cash, cash equivalents and restricted cash to consolidated balance sheets: | |||||||||||||||||
| Cash and cash equivalents | $ | 231,561 | $ | 14,767 | $ | 4,124 | |||||||||||
| Restricted cash | 231 | — | — | ||||||||||||||
| Cash, cash equivalents and restricted cash in consolidated balance sheets | $ | 231,792 | $ | 14,767 | $ | 4,124 | |||||||||||
| Supplemental non-cash items: | |||||||||||||||||
| Lapse (increase) in repurchase rights of common stock | $ | (346) | $ | (281) | $ | 24 | |||||||||||
| Purchases of property and equipment in accounts payable and accrued liabilities | $ | 65 | $ | 47 | $ | — | |||||||||||
| Accrued interest for convertible note | $ | — | $ | 496 | $ | 738 | |||||||||||
| Issuance of derivative instrument related to convertible notes | $ | 3,900 | $ | — | $ | — | |||||||||||
| Conversion of convertible note into Series G-1 convertible preferred stock | $ | — | $ | 25,133 | $ | — | |||||||||||
| Deferred offering costs in accrued liabilities and accounts payable | $ | — | $ | 995 | $ | — | |||||||||||
| Deposit for operating lease in accounts payable | $ | — | $ | 231 | $ | — | |||||||||||
| Operating lease right of use asset recorded on the adoption of ASC 842 | $ | — | $ | 1,181 | $ | — | |||||||||||
| Operating lease right of use assets obtained in exchange for new lease liabilities | $ | 3,935 | $ | 6,216 | $ | — | |||||||||||
| Supplemental disclosure of cash flow information: | |||||||||||||||||
| Cash paid for income taxes | $ | 259 | $ | 196 | $ | 226 | |||||||||||
| Cash paid for interest | $ | 3,059 | $ | 1,396 | $ | 1,361 | |||||||||||
The accompanying notes are an integral part of these consolidated financial statements.
F-8
1. Formation and Business of the Company
The Company
Pulmonx Corporation (the “Company”) was incorporated in the state of California in December 1995 as Pulmonx and reincorporated in the state of Delaware in December 2013. The Company is a commercial-stage medical technology company that provides a minimally invasive treatment for patients with severe emphysema, a form of chronic obstructive pulmonary disease (COPD). The Company’s solution, which is comprised of the Zephyr Endobronchial Valve (Zephyr Valve), the Chartis Pulmonary Assessment System (Chartis System) and the StratX Lung Analysis Platform (StratX Platform), is designed to treat a broad pool of patients for whom medical management has reached its limits and either do not want or are ineligible for surgical approaches. The Company has subsidiaries in the Cayman Islands, Germany, Switzerland, Australia, the United Kingdom, the Netherlands, Italy, France and Hong Kong.
Initial Public Offering
On September 30, 2020, the Company’s registration statement on Form S-1 (File No. 333-248635) relating to its initial public offering (“IPO”) of common stock became effective. The IPO closed on October 5, 2020 at which time the Company issued 11,500,000 shares of its common stock at a price of $19.00 per share, which included the issuance of shares in connection with the exercise by the underwriters of their option to purchase up to 1,500,000 additional shares. The Company received an aggregate of $218.5 million gross proceeds, before underwriting discounts, commissions and offering costs, and approximately $201.4 million in net proceeds after deducting underwriting discounts and commissions and offering costs.
In addition, upon closing the IPO, all outstanding shares of the Company’s convertible preferred stock converted into 17,797,026 shares of common stock. Additionally, the $33.0 million aggregate outstanding principal amount and $0.8 million accrued interest of the 2020 Notes converted into 2,561,484 shares of common stock at a conversion price of $13.20 per share. In connection with the completion of its IPO, on October 5, 2020, the Company’s certificate of incorporation was amended and restated to provide for 200,000,000 authorized shares of common stock with a par value of $0.001 per share and 10,000,000 authorized shares of preferred stock with a par value of $0.001 per share.
Liquidity and Going Concern
The Company has incurred operating losses and negative cash flows from operations to date and has an accumulated deficit of $242.7 million as of December 31, 2020. During the years ended December 31, 2020, 2019 and 2018, the Company used $30.6 million, $20.8 million and $18.4 million of cash in its operating activities, respectively. As of December 31, 2020, the Company had cash and cash equivalents of $231.6 million. Historically, the Company’s activities have been financed through private placements of equity securities, debt and sale of common stock in the IPO.
The Company’s consolidated financial statements have been prepared on the basis of the Company continuing as a going concern for the next 12 months. Management believes that the Company’s existing cash and cash equivalents will allow the Company to continue its planned operations for at least the next 12 months from the date of the issuance of these consolidated financial statements.
Impact of the COVID-19 Pandemic
The Company has been actively monitoring the novel coronavirus, or COVID-19, situation and its impact. In response to the pandemic, numerous state and local jurisdictions imposed “shelter-in-place” orders, quarantines and other restrictions. In the markets in which we operate, elective, specialty and other procedures and appointments have been suspended or canceled. In March 2020, the governor of California, where the Company’s headquarters are located, issued “stay at home” orders limiting non-essential activities, travel and business operations. Such orders or restrictions have resulted in reduced operations at the Company’s headquarters (including manufacturing facility),
F-9
work stoppages, slowdowns and delays, travel restrictions and cancellation of events and have restricted the efforts of the Company’s sales representatives, thereby significantly and adversely impacting the Company’s operations. These orders and restrictions have significantly delayed and decreased the number of procedures performed using the Company’s products and otherwise adversely impacted sales and operations.
The Company’s consolidated financial statements reflect judgments and estimates that could change in the future as a result of the COVID-19 pandemic. The COVID-19 pandemic has adversely impacted the Company’s business, financial condition and results of operations by decreasing and delaying substantially all procedures performed using the its products, and the Company expects the pandemic to continue to adversely impact its business, financial condition and results of operations for the foreseeable future.
2. Summary of Significant Accounting Policies
Basis of Presentation
The accompanying consolidated financial statements have been prepared using accounting principles generally accepted in the United States of America (“GAAP”).
Reverse Stock Split
On September 22, 2020, the Company effected a 1-for-10 reverse stock split of the Company’s common stock and convertible preferred stock. The par value and authorized shares of common stock were not adjusted as a result of the reverse stock split. All issued and outstanding common stock, convertible preferred stock, stock options and per share amounts contained in the accompanying financial statements and notes to the financial statements have been retroactively adjusted to give effect to the reverse stock split for all periods presented.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Although these estimates are based on the Company’s knowledge of current events and actions it may undertake in the future, actual results may ultimately materially differ from these estimates and assumptions.
Significant estimates and assumptions include reserves and write-downs related to inventories, the recoverability of long term assets, valuation of equity instruments and equity-linked instruments, valuation of common stock, stock-based compensation, valuation of the convertible preferred stock warrant liability and derivative liabilities, intangible assets, goodwill, debt and related features, deferred tax assets and related valuation allowances and impact of contingencies.
Fair Value of Financial Instruments
The carrying amounts of the Company’s financial instruments consisting of cash and cash equivalents, accounts receivable, accounts payable and accrued liabilities approximate fair value due to their relatively short maturities. The convertible preferred stock warrant liability and derivative liabilities were carried at fair value based on unobservable market inputs. Based on the borrowing rates currently available to the Company for debt with similar terms and consideration of default and credit risk, the carrying value of the term loan and convertible note
F-10
approximates their fair value. The fair value of marketable debt securities is estimated using Level 2 inputs based on their quoted market values (Note 4).
Cash and Cash Equivalents
The Company considers all highly liquid investments with an original maturity of three months or less at the time of purchase to be cash equivalents, which include money market funds.
Restricted Cash
Restricted cash is comprised of cash that is restricted as to withdrawal or use under the terms of certain contractual agreements. Restricted cash for years ended December 31, 2020 consists of collateral for letters of credit issued in connection with the real estate lease in Redwood City, California.
Short-Term Marketable Securities
The Company determines the appropriate classification of its investments in marketable securities at the time of purchase and reevaluates such designation at each balance sheet date. The Company has classified and accounted for its marketable securities as available-for-sale. After consideration of the Company’s risk versus reward objectives and liquidity requirements, the Company may sell these securities prior to their stated maturities. As the Company views these securities as available to support current operations, the Company classifies highly liquid securities with original maturities greater than three months at the time of purchase as short-term marketable securities on the balance sheet. These securities are carried at fair value as determined based upon quoted market prices or pricing models for similar securities. Unrealized gains and losses on available for sale debt securities, if any, are excluded from earnings and are reported as a component of accumulated other comprehensive income (loss). The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, which is included in interest income on the statements of operations and comprehensive loss. Realized gains and losses, if any, on available-for-sale securities are included in other income (expense), net. The cost of securities sold is based on the specific identification method. Interest and dividends on securities classified as available-for-sale are included in interest income. There were no short-term marketable securities as of December 31, 2020. The Company did not identify any of its short-term marketable securities as other-than-temporarily impaired as of December 31, 2019.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of risk consist principally of cash, cash equivalents and accounts receivable. The Company maintains its cash and cash equivalents balances with established financial institutions and, at times, such balances with any one financial institution may be in excess of the Federal Deposit Insurance Corporation (“FDIC”) insured limits. As of December 31, 2020 and 2019, the Company also had cash on deposit with foreign banks of approximately $5.6 million and $5.2 million, respectively, that was not federally insured.
The Company earns revenue from the sale of its products to distributors and other customers such as hospitals. Sales of Zephyr Valves and delivery catheters accounted for most of our revenue for the years ended December 31, 2020, 2019 and 2018. The Company’s accounts receivable are derived from revenue earned from distributors and customers. The Company performs ongoing credit evaluations of its customers’ and distributors’ financial condition and generally requires no collateral from its customers and distributors. At December 31, 2020 and 2019, no customer or distributor accounted for more than 10% of accounts receivable. For the years ended December 31, 2020, 2019 and 2018, no customer or distributor accounted for more than 10% of revenue.
The Company relies on single source suppliers for the components, sub-assemblies and materials for its products. These components, sub-assemblies and materials are critical and there are no or relatively few alternative sources of supply. The Company’s suppliers have generally met the Company’s demand for their products and services on a timely basis in the past.
F-11
Deferred Offering Costs
Deferred offering costs, consisting of legal, accounting and other fees and costs relating to the Company’s IPO, are capitalized and recorded on the balance sheet. As of December 31, 2019, $1.6 million of deferred offering costs were recorded on the consolidated balance sheet. During the year ended December 31, 2020, the Company wrote off deferred offering costs of $3.0 million as, in May 2020, the Company withdrew its registration statement that was filed with the SEC in February 2020. After the registration statement was withdrawn in May 2020, an additional $1.8 million in deferred offering costs were incurred related to the Company’s October IPO. In connection with the IPO, all deferred offering costs incurred after May 2020 were recorded as reduction of the gross proceeds from the IPO in the additional paid-in capital on the accompanying balance sheet as of December 31, 2020.
Accounts Receivable and Allowances
Accounts receivable are recorded at the amounts billed less estimated allowances for doubtful accounts. The Company continually monitors customer payments and maintains an allowance for estimated losses resulting from a customer’s inability to make required payments. Company considers factors such as historical experience, credit quality, age of the accounts receivable balances, geographic related risks and economic conditions that may affect a customer’s ability to pay. As of December 31, 2020 and December 31, 2019, accounts receivable is presented net of an allowance for doubtful accounts of $0 and less than $0.1 million, respectively.
Inventories
Inventories are valued at the lower of cost to purchase or manufacture the inventory or net realizable value. Cost is determined using the first-in, first-out method (“FIFO”) for all inventories. Net realizable value is determined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. The Company records write-downs of inventories which are obsolete or in excess of anticipated demand or market value based on consideration of product lifecycle stage, technology trends, product development plans and assumptions about future demand and market conditions. Inventory write-downs reduce the carrying value of inventory to its net realizable value.
Property and Equipment, Net
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets, generally between to five years. Leasehold improvements are amortized using the straight-line method over the shorter of the lease term or useful economic life of the asset. When assets are retired or otherwise disposed of, the cost and accumulated depreciation are removed from the balance sheet, and any resulting gain or loss is reflected in operations in the period realized.
Impairment of Long-lived Assets
The Company evaluates its long-lived assets for indicators of possible impairment by comparison of the carrying amounts to future net undiscounted cash flows expected to be generated by such assets when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or discounted estimates of future cash flows. The Company has not identified any such impairment losses to date.
Goodwill
Goodwill represents the excess of the purchase price over the fair value of net tangible and identified intangible assets acquired in a business combination. Goodwill is not amortized but is evaluated at least annually for impairment or when a change in facts and circumstances indicate that the fair value of the goodwill may be below its carrying value.
F-12
The Company tests goodwill for impairment at the reporting unit level (“Reporting Unit”). The Company has determined that it has only one operating segment and one Reporting Unit. The operating results are reviewed only on a consolidated basis to make decisions about resources to be allocated and assess performance. Prior to performing the impairment test, the Company assesses qualitative factors to determine whether the existence of events or circumstances would indicate that it is more likely than not that the fair value of the Reporting Unit was less than the carrying amount. If after assessing the totality of events or circumstances, the Company were to determine that it is more likely than not that the fair value of the Reporting Unit is less than the carrying amount, then the Company would perform a quantitative impairment test. The quantitative impairment test involves comparing the fair value of the Reporting Unit to the carrying value. If the fair value of the Reporting Unit exceeds the carrying value of the net assets, goodwill is not impaired, and no further testing is required. If the fair value of the Reporting Unit is less than the carrying value, the Company measures the amount of impairment loss, if any, as the excess of the carrying value over the fair value of the Reporting Unit. Estimations and assumptions regarding the future performance and results of the Company’s operations, including estimates related to future sales growth, gross margin and operating expenses, and the fair value of the Company’s common stock are used in the impairment assessment. Circumstances that could reasonably be expected to negatively affect the key assumptions related to the impairment assessment include but are not limited to, (1) a significant adverse change in legal factors affecting our existing and future products or in business climate, (2) unanticipated competition, (3) an adverse action or assessment by a regulator, or (4) an adverse change in market conditions that are indicative of a decline in the fair value of the assets.
Intangible Assets
Intangible assets consist of developed technology and trademarks. Intangible assets were recorded at their fair values at the date of acquisition and are amortized using the straight-line method over a 15-year useful life (Note 5).
Leases
The Company leases its facilities and vehicles and meets the requirements to account for these leases as operating leases. The Company recognizes rent expense on a straight-line basis over the non-cancelable lease term. Where leases contain escalation clauses, rent abatements or concessions, such as rent holidays and landlord or tenant incentives or allowances, the Company applies them in the determination of straight-line rent expense over the lease term.
Upon adoption of ASC 842, Leases, on January 1, 2019, the Company determined if an arrangement is a lease, or contains a lease, at inception. The asset component of the Company’s operating leases is recorded as right-of-use assets, and the liability component is recorded as current lease liabilities and long-term lease liabilities in the Company’s consolidated balance sheets. As of December 31, 2020 and 2019, the Company did not record any finance leases. ROU assets and lease liabilities are recognized based on the present value of the future minimum lease payments over the lease term at commencement date. As most of the Company’s leases do not provide an implicit rate, the Company uses its incremental borrowing rate, which is the estimated rate the Company would be required to pay for a fully collateralized borrowing equal to the total lease payments over the term of the lease, to determine the present value of future minimum lease payments. The ROU asset also includes any lease payments made to the lessor at or before the commencement date, minus lease incentives received, and initial direct costs incurred. The Company’s lease terms may include options to extend or terminate the lease when it is reasonably certain that the Company will exercise that option. Lease expense for minimum lease payments is recognized on a straight-line basis over the lease term. For lease agreements entered into or reassessed after the adoption of ASC 842, the Company combines lease and non-lease components. Variable lease payments are expenses as incurred.
Assumptions made by the Company at the commencement date are re-evaluated upon occurrence of certain events, including a lease modification. A lease modification results in a separate contract when the modification grants the lessee an additional right of use not included in the original lease and when lease payments increase commensurate with the standalone price for the additional right of use. When a lease modification results in a separate contract, it is accounted for in the same manner as a new lease.
F-13
Convertible Preferred Stock
The Company recorded all shares of convertible preferred stock at their respective fair values on the dates of issuance, net of issuance costs. The convertible preferred stock was recorded outside of permanent equity because while it is not mandatorily redeemable, in certain events considered not solely within the Company’s control, such as a merger, acquisition or sale of all or substantially all of the Company’s assets (each, a “deemed liquidation event”), the convertible preferred stock would become redeemable at the option of the holders of at least a majority of the then outstanding such shares. The Company had not adjusted the carrying values of the convertible preferred stock to its liquidation preference because a deemed liquidation event obligating the Company to pay the liquidation preferences to holders of shares of convertible preferred stock was not probable. Subsequent adjustments to the carrying values to the liquidation preferences would be made only when it became probable that such a deemed liquidation event would occur. All outstanding shares of the convertible preferred stock converted into common stock upon effectiveness of the IPO.
Convertible Preferred Stock Warrants
The Company’s convertible preferred stock warrants required liability classification and accounting as the underlying convertible preferred stock was considered contingently redeemable and might obligate the Company to transfer assets to the holders at a future date upon occurrence of a deemed liquidation event. The convertible preferred stock warrants were recorded at fair value upon issuance and were subject to remeasurement to fair value at each balance sheet date, with any changes in fair value recognized in the consolidated statements of operations and comprehensive loss. The Company continued to adjust the convertible preferred stock warrant liability for changes in fair value until the earlier of the exercise or expiration of the convertible preferred stock warrants, occurrence of a deemed liquidation event or conversion of convertible preferred stock into common stock.
If all outstanding shares of the series of convertible preferred stock for which the convertible preferred stock warrants were exercisable for were converted to shares of common stock or any other security, then thereafter (a) the convertible preferred stock warrants should become exercisable for such number of shares of common stock or such other security as was equal to the number of shares of common stock or such other security that each share of convertible preferred stock was converted into, multiplied by the number of shares subject to the convertible preferred stock warrants immediately prior to such conversion, and (b) the exercise price of the convertible preferred stock warrants should automatically be adjusted to equal to the number obtained by dividing (1) the aggregate exercise price for which the convertible preferred stock warrants were exercisable immediately prior to such conversion by (2) the number of shares of common stock or such other security for which the convertible preferred stock warrants were exercisable immediately after such conversion.
Revenue Recognition
The Company’s revenue is generated from the sale of its products to distributors and hospitals in the United States and international markets.
Under ASC 606, revenue is recognized when the customer obtains controls of promised goods or services, in an amount that reflects consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the Company performs the following five steps as prescribed by ASC 606:
(i)identify the contract(s) with a customer;
(ii)identify the performance obligations in the contract;
(iii)determine the transaction price;
(iv)allocate the transaction price to the performance obligations in the contract; and
F-14
(v)recognize revenue when (or as) the entity satisfies performance obligations.
A contract with a customer exists when (i) the Company enters into a legally enforceable contract with a customer that defines each party’s rights regarding the products or services to be transferred and identifies the payment terms related to these products or services, (ii) the contract has commercial substance and, (iii) the Company determines that collection of substantially all consideration for products or services that are transferred is probable based on the customer’s intent and ability to pay the promised consideration. The Company identifies performance obligations in contracts with customers, which may include its products and implied promises to provide free products and analysis services for patient scans. The transaction price is determined based on the amount expected to be entitled to in exchange for transferring the promised services or product to the customer. The Company is entitled to the total consideration for the products ordered by customers, net of early pay discounts, volume rebate adjustments and other transaction price adjustments. The Company’s payment terms to customers generally range from 30 to 60 days. Payment terms fall within the one-year guidance for the practical expedient which allows the Company to forgo adjustment of the promised amount of consideration for the effects of a significant financing component. The Company excludes taxes assessed by governmental authorities on revenue-producing transactions from the measurement of the transaction price.
Assuming all other revenue recognition criteria are met, revenue is recognized when control of the Company’s products transfers to the customer. For sales where the Company’s sales representative hand delivers product directly to the hospital or medical center control transfers to the customer upon this delivery. For sales where products are shipped, control is transferred either upon shipment or delivery of the products to the customer, depending on the shipping terms and conditions. For consignment sales, control is transferred when the products are used by the customer in procedures. The Company defers revenue relating to any remaining performance obligations by the Company to the customer after delivery, such as free products and free analysis services of patient scans to determine suitability of the patients for the treatment using the Company’s Zephyr Valves. As permitted under the practical expedient, the Company does not disclose the value of unsatisfied performance obligations for contracts with an original expected length of one year or less.
The Company accepts product returns at its discretion or if the product is defective as manufactured. Historically, the actual product returns have been immaterial to the Company’s financial statements. The Company elected to treat shipping and handling costs as a fulfillment cost and include them in the cost of goods sold as incurred. In those cases where the Company bills shipping and handling costs to customers, it will classify the amounts billed within revenue.
The Company disaggregates its revenue by major geographic region, which has been disclosed in Note 13, “Segment Information”.
The Company’s contract liabilities consist of deferred revenue for remaining performance obligations by the Company to the customer after delivery, which was $0.1 million and $0.2 million as of December 31, 2020 and December 31, 2019. The deferred revenue as of December 31, 2018 was $0.1 million, which was recognized as revenue during the year ended December 31, 2019. The deferred revenue as of December 31, 2019 of $0.2 million, which was recognized as revenue during the year ended December 31, 2020.
Costs associated with product sales include commissions. The Company applies the practical expedient and recognizes commissions as expense when incurred because the expense is incurred at a point in time and the amortization period is less than one year. Commissions are recorded as selling expense.
Cost of Goods Sold
The Company manufactures certain products at its facility and purchases other products from third party manufacturers. Cost of goods sold consists primarily of costs related to materials, components and subassemblies, third-party costs, manufacturing overhead costs, direct labor, reserves for excess, obsolete and non-sellable inventories as well as distribution-related expenses. A significant portion of the Company’s cost of goods sold currently consists of manufacturing overhead costs. These overhead costs include the cost of quality assurance,
F-15
material procurement, inventory control, facilities, equipment and operations supervision and management. Cost of goods sold also includes depreciation expense for production equipment and certain direct costs such as shipping costs.
Research and Development
Research and development expenses consist of compensation costs, stock-based compensation, engineering and research expenses, clinical trials and related expenses, regulatory expenses, manufacturing expenses incurred to build products for testing, allocated facilities costs, consulting fees and other expenses incurred to sustain the Company’s overall research and development programs. All research and development costs are expensed as incurred.
Clinical trial costs are a significant component of the Company’s research and development expenses. The Company has a history of contracting with third parties that perform various clinical trial activities on the Company’s behalf in the ongoing development of its product candidates. The financial terms of these contracts are subject to negotiations and may vary from contract to contract and may result in uneven payment flow. The Company accrues and expenses costs for its clinical trial activities performed by third parties, including clinical research organizations and other service providers, based upon estimates of the work completed over the life of the individual study in accordance with associated agreements. The Company determines these estimates through discussion with internal personnel and outside service providers as to progress or stage of completion of trials or services pursuant to contracts with clinical research organizations and other service providers and the agreed-upon fee to be paid for such services.
Advertising Costs
The Company expenses the costs of advertising as incurred. Advertising expenses were $1.5 million, $0.6 million and $0.1 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Foreign Currency Translation and Transaction Gains and Losses
The functional currencies of the Company’s wholly owned subsidiaries in the Cayman Islands and the Netherlands are the U.S. dollar. The functional currencies of the Company’s wholly owned subsidiaries in Switzerland, Germany, Australia, the United Kingdom, France and Hong Kong are the Swiss franc. The functional currency of the Company’s subsidiary in Italy is the Euro. Accordingly, asset and liability accounts of Switzerland, Germany, Australia, the United Kingdom, Italy and Hong Kong operations are translated into U.S. dollars using the current exchange rate in effect at the balance sheet date and equity accounts are translated into U.S. dollars using historical rates. The revenues and expenses are translated using the average exchange rates in effect during the period, and gains and losses from foreign currency translation adjustments are included as a component of accumulated other comprehensive income in the consolidated balance sheet. Foreign currency translation adjustments are recorded in other comprehensive income (loss) in the consolidated statements of operations and comprehensive loss and was $0.3 million, less than $0.1 million and $0.1 million during the years ended December 31, 2020, 2019 and 2018, respectively.
Foreign currency transaction gains and losses are included in other income (expense), net in the consolidated statements of operations and comprehensive loss and was $0.1 million, $(0.1) million and $(0.3) million during the years ended December 31, 2020, 2019 and 2018, respectively.
Stock-Based Compensation
The Company accounts for stock-based compensation arrangements with employees and non-employees in accordance with ASC 718, Compensation—Stock Compensation, using a fair-value based method. The Company determines the fair value of all stock options and ESPP awards on the date of grant using the Black-Scholes option pricing model. The Company’s determination of the fair value is impacted by its common stock price as well as assumptions regarding a number of complex and subjective variables. These variables include, but are not limited to, the expected term that options will remain outstanding, expected common stock price volatility over the term of the
F-16
option awards, risk-free interest rates and expected dividends. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation expense is recognized. These inputs are subjective and generally require significant analysis and judgment to develop.
The fair value of time-based awards is recognized over the period during which an option holder is required to provide services in exchange for the option award, known as the requisite service period, which is typically the vesting period using the straight-line method. The fair value of performance-based awards is recognized over the requisite service period using the graded vesting method. The Company accounts for forfeitures as they occur.
The Company issued stock options in exchange for the receipt of goods or services from non-employees. Costs for such equity instruments are measured at the fair value of the equity instruments issued on the measurement date as the Company believes that the fair value of the equity instrument is more reliably measured than the fair value of the services received. Up to December 31, 2018, the value of equity instruments issued to non-employees was determined on the earlier of the date on which there first existed a firm commitment for performance by the provider of goods and services or on the date performance is complete, using the Black-Scholes option pricing model. Therefore, the measurement of stock-based compensation issued to non-employees was subject to periodic adjustment as the underlying equity instruments vested. Stock-based compensation expense related to stock options granted to non-employees was recognized as the stock options are earned. Upon adoption of ASU 2018-07 for the periods after January 1, 2019, the Company accounts for shared-based awards granted to non-employees based on the fair value on the date of grant and recognizes compensation expense for those awards over the requisite service period, which is generally the vesting period of the respective award.
Fair Value of Common Stock
Prior to the Company’s IPO, the fair value of the Company’s common stock was determined by the board of directors with assistance from management and external appraisers. Management’s approach to estimate the fair value of the Company’s common stock was consistent with the methods outlined in the American Institute of Certified Public Accountants’ Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation (“Practice Aid”). Management considered several factors to estimate enterprise value, including significant milestones that would generally contribute to increases in the value of the common stock. Subsequent to the Company’s IPO, the fair value of the Company’s common stock is determined based on its closing market price.
Income Taxes
The Company accounts for income taxes under the asset and liability method, whereby deferred tax assets and liabilities are determined based on the difference between the consolidated financial statements and tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to affect taxable income. A valuation allowance is established when necessary to reduce deferred tax assets when management estimates, based on available objective evidence, that it is more likely than not that the benefit will not be realized for the deferred tax assets.
The Company also follows the provisions of ASC 740-10, Accounting for Uncertainty in Income Taxes. ASC 740-10 prescribes a comprehensive model for the recognition, measurement, presentation and disclosure in financial statements of any uncertain tax positions that have been taken or expected to be taken on a tax return. No liability related to uncertain tax positions is recorded on the consolidated financial statements. It is the Company’s policy to include penalties and interest expense related to income taxes as part of the provision for income taxes.
Net Loss per Share Attributable to Common Stockholders
Basic net loss per common share is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of common stock outstanding during the period, without consideration of potentially dilutive securities. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders by the weighted-average number of common stock and potentially dilutive securities outstanding for the period. For purposes of the diluted net loss per share calculation, convertible preferred stock, stock options,
F-17
common stock subject to repurchase related to early exercise of stock options, convertible preferred stock warrants and convertible note are considered to be potentially dilutive securities. Basic and diluted net loss attributable to common stockholders per share is presented in conformity with the two-class method required for participating securities as the convertible preferred stock is considered a participating security because it participates in dividends with common stock. The Company also considers the shares issued upon the early exercise of stock options subject to repurchase to be participating securities, because holders of such shares have non-forfeitable dividend rights in the event a dividend is paid on common stock. The holders of all series of convertible preferred stock and the holders of the shares issued upon early exercise of stock options subject to repurchase do not have a contractual obligation to share in the Company’s losses. As such, the net loss was attributed entirely to common stockholders. Because the Company has reported a net loss for all periods presented, diluted net loss per common share is the same as basic net loss per common share for those periods.
Comprehensive Loss
The Company is required to report all components of comprehensive loss, including net loss, in the financial statements in the period in which they are recognized. Comprehensive loss is defined as a change in equity of a business enterprise during a period, resulting from transactions and other events and circumstances from non-owner sources. The Company’s currency translation adjustment and unrealized gains and losses from marketable securities are the components of other comprehensive loss that are excluded from the reported net loss for all periods presented.
3. Recent Accounting Pronouncements
Recently Adopted Accounting Pronouncements
In August 2018, FASB issued ASU 2018-13, Fair Value Measurement (Topic 820), Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement. This ASU amends the disclosure requirement in ASC 820, Fair Value Measurement, by adding, changing or removing certain disclosures. This ASU applies to all entities that are required under this guidance to provide disclosure about recurring or nonrecurring fair value measurements. The amendments require new disclosures related to: changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period; range and weighted-average of significant unobservable inputs used to develop Level 3 fair value measurements. In addition, there are certain changes in disclosure requirements in the existing guidance. For all entities, this ASU is effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years. Early adoption is permitted. The Company adopted ASU 2018-13 as of January 1, 2020 and the adoption had no material impact on the Company’s consolidated financial statements.
In January 2017, the FASB issued ASU 2017-04, Intangibles – Goodwill and Other: Simplifying the Test for Goodwill Impairment. The amendments eliminate Step 2 from the goodwill impairment test. The annual, or interim, goodwill impairment test is performed by comparing the fair value of a reporting unit with its carrying amount. An impairment charge should be recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value; however, the loss recognized should not exceed the total amount of goodwill allocated to that reporting unit. In addition, income tax effects from any tax deductible goodwill on the carrying amount of the reporting unit should be considered when measuring the goodwill impairment loss, if applicable. The amendments also eliminate the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. An entity still has the option to perform the qualitative assessment for a reporting unit to determine if the quantitative impairment test is necessary. This ASU is effective for public business entities for its annual or any interim goodwill impairment tests in fiscal years beginning after December 15, 2019. Early adoption is permitted. The Company adopted ASU 2017-04 as of January 1, 2020 and the adoption had no material impact on the Company’s consolidated financial statements.
F-18
Recent Accounting Pronouncements Not Yet Adopted
In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848) (“ASU 2020-04”). The amendments in ASU 2020-04 provide optional expedients and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. The amendments in ASU 2020-04 are effective for all entities as of March 12, 2020 through December 31, 2022. An entity may elect to apply the amendments for contract modifications by Topic or Industry Subtopic as of any date from the beginning an interim period that includes or is subsequent to March 12, 2020, or prospectively from the date that the financial statements are available to be issued. Once elected for a Topic or an Industry Subtopic, the amendments must be applied prospectively for all eligible contract modifications for that Topic or Industry Subtopic. The Company may elect to apply ASU 2020-04 as its contracts referenced in London Interbank Offered Rate (“LIBOR”) are impacted by reference rate reform. The Company is currently evaluating the impact of the adoption of this ASU on the Company’s consolidated financial statements.
In August 2020, the FASB issued ASU No. 2020-06, Debt—Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging—Contracts in Entity's Own Equity (Subtopic 815-40)—Accounting For Convertible Instruments and Contracts in an Entity's Own Equity (“ASU 2020-06”). ASU 2020-06 simplifies accounting for convertible instruments by removing major separation models required under current GAAP. Consequently, more convertible debt instruments will be reported as a single liability instrument with no separate accounting for embedded conversion features. ASU 2020-06 removes certain settlement conditions that are required for equity contracts to qualify for the derivative scope exception, which will permit more equity contracts to qualify for it. ASU 2020-06 also simplifies the diluted net income per share calculation in certain areas. This ASU is effective for the Company for fiscal years beginning after December 15, 2023, and interim periods within those fiscal years, with early adoption permitted for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of this principle on the Company’s consolidated financial statements.
In December 2019, the FASB issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. This ASU is effective for public business entities for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. The Company is currently evaluating the impact of the adoption of ASU 2019-12 on the Company’s consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses. This new guidance will require financial instruments to be measured at amortized cost, and trade accounts receivable to be presented at the net amount expected to be collected. The new model requires an entity to estimate credit losses based on historical information, current information and reasonable and supportable forecasts, including estimates of prepayments. In November 2019, the FASB issued ASU 2019-10, according to which, the new standard is effective for public business entities that meet the definition of an SEC filer, excluding entities eligible to be smaller reporting companies (“SRC”) as defined by the SEC, for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. For all other entities , the new standard is effective for fiscal years beginning after December 15, 2022, and interim periods within that fiscal year. Early adoption is permitted. The Company is a SRC for fiscal year 2019 and 2020. The Company is currently evaluating the impact of the new standard on the Company’s consolidated financial statements.
4. Fair Value Measurements
Assets and liabilities recorded at fair value in the consolidated financial statements are categorized based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels which are directly
F-19
related to the amount of subjectivity associated with the inputs to the valuation of these assets or liabilities are as follows:
Level 1 – Inputs are unadjusted quoted prices in active markets for identical assets or liabilities that the Company has the ability to access as of the measurement date.
Level 2 – Inputs are observable, unadjusted quoted prices in active markets for similar assets or liabilities, unadjusted quoted prices for identical or similar assets or liabilities in markets that are not active or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities;
Level 3 – Unobservable inputs for the asset or liability only used when there is little, if any, market activity for the asset or liability at the measurement date. This hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.
Assets and Liabilities Measured and Recorded at Fair Value on a Recurring Basis – Financial assets and liabilities held by the Company measured at fair value on a recurring basis include money market funds, short-term marketable securities, convertible preferred stock warrant liability and derivative liability.
Assets and Liabilities Measured and Recorded at Fair Value on a Nonrecurring Basis – The Company determines the fair value of long-lived assets held and used, such as intangible assets, by reference to independent appraisals, quoted market prices (e.g. an offer to purchase) and other factors. An impairment charge is recorded when the carrying value of the asset exceeds its fair value. As noted above, there have been no impairment charges recorded to date. Based on the borrowing rates currently available to the Company for debt with similar terms and consideration of default and credit risk, the carrying value of the term loan and convertible note payable to related party approximates their fair value and is classified as a Level 2 liability.
Assets and liabilities measured at fair value are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement in its entirety requires management to make judgments and consider factors specific to the asset or liability.
The following tables summarizes the types of assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):
| December 31, 2020 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||
| Assets: | |||||||||||||||||||||||
Money market funds | $ | 10,533 | $ | — | $ | — | $ | 10,533 | |||||||||||||||
| Cash equivalents | 10,533 | — | — | 10,533 | |||||||||||||||||||
| Total financial assets | $ | 10,533 | $ | — | $ | — | $ | 10,533 | |||||||||||||||
There were no liabilities measured at fair value on a recurring and non-recurring basis as of December 31, 2020.
F-20
| December 31, 2019 | |||||||||||||||||||||||
| Level 1 | Level 2 | Level 3 | Total | ||||||||||||||||||||
| Assets: | |||||||||||||||||||||||
Money market funds | $ | 6,318 | $ | — | $ | — | $ | 6,318 | |||||||||||||||
Commercial paper | — | 1,000 | — | 1,000 | |||||||||||||||||||
| Cash equivalents | 6,318 | 1,000 | — | 7,318 | |||||||||||||||||||
Corporate bonds | — | 7,105 | — | 7,105 | |||||||||||||||||||
Commercial paper | — | 6,475 | — | 6,475 | |||||||||||||||||||
| Short-term marketable securities | — | 13,580 | — | 13,580 | |||||||||||||||||||
| Total financial assets | $ | 6,318 | $ | 14,580 | $ | — | $ | 20,898 | |||||||||||||||
| Liabilities: | |||||||||||||||||||||||
Preferred stock warrant liability | $ | — | $ | — | $ | — | $ | — | |||||||||||||||
Derivative liability | — | — | 1,165 | 1,165 | |||||||||||||||||||
| Total financial liabilities | $ | — | $ | — | $ | 1,165 | $ | 1,165 | |||||||||||||||
The following table summarizes the cost, unrealized gains and losses and fair value of marketable securities (in thousands):
| December 31, 2019 | |||||||||||||||||||||||
| Amortized Cost | Unrealized Losses | Unrealized Gains | Fair Value | ||||||||||||||||||||
Corporate bonds | $ | 7,103 | $ | — | $ | 2 | $ | 7,105 | |||||||||||||||
Commercial paper | 7,471 | — | 4 | 7,475 | |||||||||||||||||||
| Marketable securities | $ | 14,574 | $ | — | $ | 6 | $ | 14,580 | |||||||||||||||
Amounts recognized on the consolidated balance sheet | |||||||||||||||||||||||
Cash equivalents | $ | 1,000 | |||||||||||||||||||||
Short-term marketable securities | 13,580 | ||||||||||||||||||||||
| Marketable securities | $ | 14,580 | |||||||||||||||||||||
At December 31, 2019, accrued interest on marketable securities of $0.1 million was included in prepaid expenses and other current assets on the consolidated balance sheet.
The Company did not have marketable securities as of December 31, 2020.
The Company values the convertible preferred stock warrant liability (Note 9) using the Black-Scholes Merton option-pricing model. The expected term for these warrants is based on the remaining contractual life of these warrants. The expected volatility assumption was determined by examining the historical volatility for industry peers, as the Company does not have a trading history for its common stock. The risk-free interest rate assumption is based on U.S. Treasury investments whose term is consistent with the expected term of the warrants. The expected dividend assumption is based on the Company’s history and expectation of dividend payouts.
F-21
The fair value of the Series C-1 convertible preferred stock warrants was determined using the following assumptions:
| December 31, | ||||||||
| 2019 | ||||||||
| Risk-free interest rate | 1.6 | % | ||||||
| Remaining contractual life (in years) | 0.1 | |||||||
| Dividend yield | 0 | % | ||||||
| Volatility | 57.5 | % | ||||||
Derivative liabilities include derivatives associated with the Company’s Success Fee Agreement with Oxford Finance LLC (Note 6) and the 2020 Notes derivative liability (Note 6).
The Company valued Success Fee derivative liability based on the Success Fee amount of $1.9 million and the probability and estimated timing of a liquidity event. The probability of occurrence of a Liquidity Event was estimated to be up to 65% before the expiration of the agreement as of December 31, 2019. Changes in the estimated probability may result in an increase or decrease in the fair value of the derivative liability. On October 5, 2020, the Success Fee derivative liability was settled upon the Company paying $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC.
The Company valued the 2020 Notes derivative liability using the “with and without” methodology. The “with and without” methodology involves valuing the convertible note on an as is basis and then valuing the 2020 Notes without each individual embedded derivative. The difference between the value of the 2020 Notes with the embedded derivatives and the value without each individual embedded derivative equals the fair value of that embedded derivative. In April 2020, the Company valued the embedded derivatives using a Monte Carlo Simulation (“MCS”). The first step of each simulation was to forecast the Company’s Series G-1 convertible preferred stock price through the expiration of the 2020 Notes. In order to estimate the future share price of the Series G-1 convertible preferred stock, the Company applied a “random walk” model based upon a Geometric Brownian Motion process with a constant drift.
The fair value of the 2020 Notes derivative liability was determined using the following assumptions:
| April 17, | |||||
| 2020 | |||||
| Risk-free interest rate | 0.2 | % | |||
| Current Series G-1 convertible preferred stock value per share | $ | 0.84 | |||
| Series G-1 convertible preferred stock volatility | 34.4 | % | |||
F-22
Upon the closing of the IPO in October 2020, the 2020 Notes converted pursuant to a qualified initial public offering (Note 6). As a result, the Company concluded that the 2020 Notes derivative had no value upon the closing of the IPO, because value of the notes with and without the such derivative was the same.
The change in fair value of the convertible preferred stock warrant liability and derivative liabilities is summarized below (in thousands):
| Convertible Preferred Stock Warrant Liability | Success Fee Derivative Liability | 2020 Notes Derivative Liability | |||||||||||||||
| Beginning fair value, January 1, 2018 | $ | — | $ | — | $ | — | |||||||||||
| Change in fair value | 12 | 642 | — | ||||||||||||||
| Ending fair value, December 31, 2018 | $ | 12 | $ | 642 | $ | — | |||||||||||
Beginning fair value, January 1, 2019 | 12 | 642 | — | ||||||||||||||
Change in fair value | (12) | 523 | — | ||||||||||||||
| Ending fair value, December 31, 2019 | $ | — | $ | 1,165 | $ | — | |||||||||||
Beginning fair value, January 1, 2020 | — | 1,165 | — | ||||||||||||||
| Fair value at inception | — | — | 3,900 | ||||||||||||||
Change in fair value | — | 710 | (3,900) | ||||||||||||||
| Payment of Success Fee | — | (1,875) | — | ||||||||||||||
| Ending fair value, December 31, 2020 | $ | — | $ | — | $ | — | |||||||||||
5. Balance Sheet Components
Cash and Cash Equivalents
The Company’s cash and cash equivalents consist of the following (in thousands):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Cash | $ | 221,028 | $ | 7,449 | |||||||
| Cash equivalents: | |||||||||||
Money market funds | 10,533 | 6,318 | |||||||||
Commercial paper | — | 1,000 | |||||||||
| Total cash and cash equivalents | $ | 231,561 | $ | 14,767 | |||||||
Inventory
Inventory consists of the following (in thousands):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Raw materials | $ | 3,342 | $ | 1,950 | |||||||
| Work in process | 227 | 180 | |||||||||
| Finished goods | 7,172 | 3,482 | |||||||||
| Total inventory | $ | 10,741 | $ | 5,612 | |||||||
F-23
Prepaid Expenses and Other Current Assets
Prepaid expenses and other current assets consist of the following (in thousands):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Prepaid expenses | $ | 381 | $ | 436 | |||||||
| Prepaid insurance | 2,131 | 12 | |||||||||
| VAT receivable | 339 | 387 | |||||||||
| Other current assets | 377 | 766 | |||||||||
| Total prepaid expenses and other current assets | $ | 3,228 | $ | 1,601 | |||||||
Property and Equipment, Net
Property and equipment, net consist of the following (in thousands):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Machinery and equipment | $ | 1,447 | $ | 1,269 | |||||||
| Computer equipment and software | 1,062 | 848 | |||||||||
| Furniture and fixtures | 229 | 168 | |||||||||
| Leasehold improvements | 57 | 57 | |||||||||
| Construction in progress | 452 | — | |||||||||
| Total | 3,247 | 2,342 | |||||||||
| Less: accumulated depreciation | (1,773) | (1,440) | |||||||||
| Property and equipment, net | $ | 1,474 | $ | 902 | |||||||
Depreciation expense for the years ended December 31, 2020, December 31, 2019 and December 31, 2018 was $0.3 million, $0.2 million and $0.1 million, respectively.
Goodwill
Goodwill was $2.3 million as of December 31, 2020 and December 31, 2019 arising from the Company’s acquisition of Emphasys Medical, Inc, in March 2009. No goodwill impairment losses have been recognized since the acquisition. There were no acquisitions or dispositions of goodwill in 2020 and 2019. The Company performed an annual test for goodwill impairment in the fourth quarter of the fiscal years ended December 31, 2020 and December 31, 2019 and determined that goodwill was not impaired.
Intangible Assets
Intangible assets consist of the following (in thousands):
| December 31, 2020 | |||||||||||||||||
| Gross Carrying Value | Accumulated Amortization | Net Carrying Value | |||||||||||||||
| Developed technology | $ | 1,658 | $ | (1,299) | $ | 359 | |||||||||||
| Trademarks | 191 | (150) | 41 | ||||||||||||||
| Total intangible assets | $ | 1,849 | $ | (1,449) | $ | 400 | |||||||||||
F-24
| December 31, 2019 | |||||||||||||||||
| Gross Carrying Value | Accumulated Amortization | Net Carrying Value | |||||||||||||||
| Developed technology | $ | 1,658 | $ | (1,188) | $ | 470 | |||||||||||
| Trademarks | 191 | (137) | 54 | ||||||||||||||
| Total intangible assets | $ | 1,849 | $ | (1,325) | $ | 524 | |||||||||||
Amortization expense relating to the intangibles totaled $0.1 million during each of the years ended on December 31, 2020, 2019 and 2018.
Future amortization expense is as follows (in thousands):
| Year Ending December 31, | |||||
| 2021 | $ | 123 | |||
| 2022 | 123 | ||||
| 2023 | 123 | ||||
| 2024 | 31 | ||||
Total amortization expense | $ | 400 | |||
Accrued Liabilities
Accrued liabilities consist of the following (in thousands):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| Accrued employee bonuses | $ | 2,374 | $ | 3,064 | |||||||
Accrued vacation | 1,810 | 1,098 | |||||||||
Other accrued personnel related expenses | 1,368 | 705 | |||||||||
Accrued professional fees | 1,313 | 1,342 | |||||||||
| Accrued interest | — | 1,708 | |||||||||
| Sales taxes, franchise tax and VAT | 521 | 762 | |||||||||
| Liability for early exercise of stock options | 629 | 304 | |||||||||
| Other | 636 | 480 | |||||||||
| Total accrued liabilities | $ | 8,651 | $ | 9,463 | |||||||
6. Long Term Debt and Convertible Notes
Term Loan
Oxford Finance Loan
In August 2014, the Company entered into a Loan and Security Agreement with Oxford Finance LLC for up to $20.0 million in term loans. In 2014, the Company borrowed $15.0 million and had the ability to draw an additional $5.0 million conditioned upon the achievement of a revenue milestone. The period during which the Company could draw an additional $5.0 million ended on November 30, 2015 without the Company borrowing the additional $5.0 million. The term loan bore interest at 8.96% and had a five-year term. The first 36 months were interest only payments followed by 24 months of equal payments of principal and interest. A final payment of 8.50% of the term loan amount is due at maturity and is being accreted using the effective interest rate method. The term loan is collateralized by assets, including cash and cash equivalents, accounts receivable and property and equipment.
F-25
In May 2017, the Company entered into a First Amendment to Loan and Security Agreement that extended the interest only period through June 2018 and included an additional fee of $0.1 million due upon maturity. The amendment was accounted for as a debt modification and no gain or loss is recognized in the Company’s financial statements.
In May 2018, the Company entered into Second and Third Amendments to Loan and Security Agreement that extended the interest only period through May 2019 and the maturity date to July 1, 2020. The amendment was accounted for as a debt modification and no gain or loss is recognized in the Company’s financial statements. The Company had the option to further extend the interest only period through March 2020 and the maturity date to May 1, 2021, provided that no event of default had occurred. The loan bears interest at an annual rate equal to the greater of (i) 8.71% and (ii) the sum of (a) the greater of the one month U.S. LIBOR rate on the last business day of the month that immediately precedes the month in which the interest will accrued and 1.85% plus (b) 6.86%. In May 2019, the Company elected to extend the interest only period of the term loan through March 2020 and the maturity date to May 2021. The incremental amendment fee, due at maturity, increased to $0.8 million from $0.4 million when the Company extended the interest only period through March 2020. As of February 20, 2020 (repayment date), December 31, 2019 and December 31, 2018, the term loan had an annual effective interest rate of 11.11% per year, 11.11% per year and 11.17% per year, respectively.
In connection with the original agreement in August 2014, the Company also entered into the Success Fee Agreement. In the event of a sale or other disposition by the Company of all or substantially all of its assets, a merger or consolidation, or an initial public offering (a “Liquidity Event”), before the termination of the agreement on August 28, 2021, the Company is required to pay up to $2.5 million (the “Success Fee”) to Oxford Finance LLC. The Success Fee is equal to 6.25% of the term loan if the Liquidity Event occurs within 18 months of August 28, 2014, 8.75% if the Liquidity Event occurs after 18 months and within 3 years of August 28, 2014, and 12.50% if the Liquidity Event occurs after the third anniversary of August 28, 2014. As of December 31, 2019, the maximum amount of Success Fee subject to a potential payout was $1.9 million. This agreement has been identified as a freestanding derivative under ASC 815, Derivatives (“Success Fee”) and is remeasured to its fair value at the end of each reporting period and any change in fair value is recognized as change in other income (expense), net in the statements of operations and comprehensive loss (Note 4). The fair value of the Success Fee derivative liability as of December 31, 2019 was $1.2 million. On October 5, 2020, in connection with the IPO, the Company paid $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC.
The Loan and Security Agreement contained customary affirmative and negative covenants and events of default. As of December 31, 2019, the Company was in default with a covenant in the Loan and Security Agreement resulting from its failure to maintain cash balances outside the United States within the levels set forth in the Loan and Security Agreement. This event of default was waived by Oxford Finance LLC.
On February 20, 2020, the Company repaid its entire obligation under the term loan agreement with Oxford Finance LLC amounting to $17.3 million, including outstanding loan amount of $15.0 million, final payment of $1.3 million, amendment fees of $0.9 million and accrued interest of $0.1 million. The repayment of the obligation under the term loan agreement with Oxford Finance LLC was accounted as extinguishment and the Company recorded a loss on extinguishment of $0.4 million included in interest expense in the consolidated statements of operations and comprehensive loss.
The term loan consisted of the following (in thousands):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
Term loan | $ | — | $ | 15,000 | |||||||
Less: debt issuance costs | — | (27) | |||||||||
Less: deferred financing costs | — | (8) | |||||||||
Term loan | $ | — | $ | 14,965 | |||||||
F-26
The Company incurred fees and legal expenses of $0.1 million in connection with the Agreement and Amendments, which are recorded as deferred financing costs and amortized to interest expense. The Company also paid $0.2 million in fees to the lender which is reflected as a discount on the debt and is being accreted over the life of the term loan. In 2020, 2019 and 2018, the Company recorded interest expense related to deferred financing and debt issuance costs of less than $0.1 million.
Interest expense on the term loan amounted to $0.4 million, $1.7 million and $1.7 million during the years ended December 31, 2020, December 31, 2019 and December 31, 2018, respectively.
CIBC Loan
On February 20, 2020, the Company executed a Loan and Security Agreement (the “CIBC Agreement”) with Canadian Imperial Bank of Commerce (“CIBC”) to raise up to $32.0 million in debt financing (“CIBC Loan”) consisting of $17.0 million advanced at the closing of the agreement (Tranche A), with the option to drawing up to an additional $8.0 million (Tranche B) on or before February 20, 2022. The term loan also provided for an additional financing tranche (Tranche C) of up to $7.0 million on or prior to February 20, 2022, which was conditioned upon achieving a trailing six-month revenue of at least $20.0 million as of the date of any Tranche C borrowing. The availability of Tranche B and Tranche C is further conditioned upon the joining of Pulmonx International Sàrl to the CIBC Agreement and the execution by Pulmonx International Sàrl of Swiss-law collateral documentation in favor of CIBC. The CIBC Loan originally had a five-year term maturing on February 20, 2025, which included 24 months of interest only payments followed by 36 months of equal payments of principal and interest. The interest only period can be extended to 36 months if the Company achieves three-month trailing revenue of at least $20.0 million as of February 20, 2022. The CIBC Loan bears interest at a floating rate equal to 1.0% above the Wall Street Journal Prime Rate at any time. The Tranche C loan will bear interest at a floating rate equal to 1.5% above the Wall Street Journal Prime Rate at any time. The CIBC Loan is collateralized by substantially all of the Company’s assets, including cash and cash equivalents, accounts receivable, intellectual property and equipment. The Company may prepay the loan, subject to certain requirements. The CIBC Agreement includes customary restrictive covenants, financial covenants, events of default and other customary terms and conditions.
In April 2020, the Company entered into a First Amendment to CIBC Agreement that changed the maturity date to March 15, 2022, which shall be automatically extended to February 20, 2025 if the maturity of all outstanding convertible notes (see below) is extended to a date no earlier than May 21, 2025 or all convertible notes have been converted into convertible preferred stock of the Company. The Company paid to CIBC an amendment fee of $0.2 million. The Tranche B drawing was amended and is conditioned to achieving a trailing six-month revenue of at least $15.0 million as of the date of any Tranche B borrowing. On the date of drawing Tranche B Loan or Tranche C Loan, the Company will pay a structuring fee in an amount equal to 1.0% of the amount of Tranche B Loan or Tranche C Loan. The amendment was accounted for as a debt modification and no gain or loss was recognized. As of December 31, 2020, the CIBC Loan had an annual effective interest rate of 5.16% per year.
In December 2020, to address certain post-close covenants for which the Company was not in compliance, the Company entered into a Second Amendment to the CIBC Agreement that extended the compliance date for certain post-close covenants to June 30, 2021.
The financial covenants in the CIBC Agreement require the Company to have revenue for the trailing three-month period ending on March 31, 2021, and the last day of each June, September, December and March thereafter of not less than the greater of (i) the amount equal to 80% of the revenue for the trailing three-month period ending on such day, as set forth in the annual projections delivered to the CIBC, and approved by CIBC, and (ii) the revenue for the trailing three-month period ending on the last day of the month for which this covenant had most recently been tested prior to such day. Further, the Company on and at all times after April 17, 2020, maintain unrestricted cash in an aggregate amount equal to or greater than the Adjusted EBITDA loss as defined in the CIBC Agreement for the four-month period ending on any date of determination. As of December 31, 2020, the Company was in compliance with all the covenants contained in the CIBC Agreement.
The CIBC Loan as of December 31, 2020, consisted of the following (in thousands):
F-27
| December 31, | ||||||||
| 2020 | ||||||||
Term loan | $ | 17,000 | ||||||
Less: debt issuance costs | (196) | |||||||
Term loan | $ | 16,804 | ||||||
The Company paid $0.3 million fees to the lender and third parties, including the amendment fee of $0.2 million, which is reflected as a discount on the CIBC Loan and is being accreted over the life of the term loan using the effective interest method. During the year ended December 31, 2020, the Company recorded interest expense related to debt discount and debt issuance costs of CIBC Loan of $0.1 million.
Interest expense on the CIBC Loan amounted $0.7 million during the year ended December 31, 2020.
Credit Agreement
In April 2020, Pulmonx International Sàrl, a wholly-owned subsidiary of the Company, entered into a COVID-19 Credit Agreement with UBS Switzerland AG to receive up to 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under Swiss Federal Government program to mitigate the economic impact of the spread of the coronavirus. In May 2020, Pulmonx International Sàrl received 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under the COVID-19 Credit Agreement. The COVID-19 Credit Agreement will bear no interest and is payable within 60 months after receipt of funds. As of December 31, 2020, Pulmonx International Sàrl did not make any repayment of credit agreement.
Paycheck Protection Program
On April 16, 2020, the Company received $2.7 million in support from the Paycheck Protection Program (the “PPP”) established by the U.S. federal government as part of the CARES Act for the PPP. Because the U.S. government subsequently changed its position and guidelines related to the PPP and publicly traded companies, the Company repaid the loan on May 1, 2020.
Convertible Note
In May 2017, the Company entered into a Second Lien Loan and Security Agreement with Boston Scientific Corporation, an investor, for up to $30.0 million in term loans. The loans under this agreement are subordinated to the term loan with Oxford Finance LLC and are also collateralized by assets, including cash and cash equivalents, accounts receivable and property and equipment. Under the Agreement, Boston Scientific Corporation agreed to make one or more term loans to the Company during the period beginning in May 2017 and ending on May 13, 2022, the maturity date (the “Term Loans”). The principal amount outstanding under the Term Loans drawn prior to June 30, 2018 accrued no interest from the date of such Term Loan through and including June 30, 2018. Beginning on July 1, 2018, all Term Loans accrued interest at a fixed rate of 8.96%. Interest accrues until such Term Loan is converted to stock or paid in full. Each Term Loan is evidenced by a separate Secured Convertible Promissory Note and is repayable, convertible and exchangeable.
If the Company completes any Qualified Equity or Debt Financing or any Change of Control, Liquidation or Prepayment Conversion occurs, outstanding principal and accrued interest on the loans are convertible at Boston Scientific Corporation’s option into shares of either (1) the Series F-1 convertible preferred stock or, if the shares of Series F-1 convertible preferred stock are not the most senior series of preferred stock of the Company then issued and outstanding (2) the most senior series of preferred stock of the Company then issued and outstanding (“Conversion Stock”). The Conversion Stock Per Share Price is defined as (A) with respect to a Qualified Equity Financing, the lowest price per share of Conversion Stock paid by any investor in such Qualified Equity Financing, (B) with respect to a Change of Control or Liquidation, the total amount distributed, paid or to be paid to the stockholders of the Company on account of the stock held by them in connection with such Change of Control or Liquidation, divided by the fully-diluted share count of the Company on the Conversion Date or (C) with respect to
F-28
a Prepayment Conversion, $230,000,000 divided by the fully-diluted share count of the Company on the Conversion Date.
Subject to Boston Scientific Corporation’s conversion rights, the Company had the option to prepay all of the Term Loans, at any time.
In conjunction with the Second Lien Loan and Security Agreement, the Company and Boston Scientific entered into a No Shop Agreement such that from the date of execution of the agreement through the earlier of the Company’s submission of the final module of its Premarket Approval application to the FDA and March 31, 2018, the Company would not sign a term sheet or engage in discussions to sell the Company. In addition, Boston Scientific’s Right of First Negotiation, originally received as part of the Preferred Series F-1 financing, was amended to shorten the period it has to exercise its Right of First Negotiation from 10 to 5 business days, and to shorten the Exclusive Negotiation Period from 75 to 45 days with respect to the initial notice from the Company that it intends to pursue a change in control or IPO. For subsequent notices from the Company, Boston Scientific has 10 days to exercise its right of first negotiation, and 75 days to enter into definitive agreements for a change in control transaction.
The Company borrowed $6.0 million in 2017, $12.0 million in 2018 and $6.0 million in January 2019 under the Second Lien Loan and Security Agreement with Boston Scientific Corporation.
In April 2019, all the Term Loans and accrued interest of $25.1 million under the agreement converted into 1,903,935 shares of Series G-1 convertible preferred stock at a price of $13.2 per share at the option of Boston Scientific Corporation upon the occurrence of Series G-1 convertible preferred stock financing, which met the definition of Qualified Equity Financing in the Second Lien Loan and Security Agreement (Note 10). This conversion was accounted as debt extinguishment and the Company recognized less than $0.1 million extinguishment gain upon such conversion.
The Company incurred fees and legal expenses of $0.1 million in connection with the Agreement, which are reported on the balance sheet as a direct deduction from the face amount of the convertible note. Amortization of the issuance costs are calculated using the effective interest rate method over the term of the note and recorded as a non-cash interest expense. In 2018, the Company accrued interest expense of $0.8 million, which was included in convertible notes at December 31, 2018. As of December 31, 2018, the Term Loans had an annual effective interest rate of 7.47% per year.
The Second Lien Loan and Security Agreement contains customary affirmative and negative covenants and events of default. As of December 31, 2019 and December 31, 2018, the Company was in compliance with all the covenants contained in the Second Lien Loan and Security Agreement.
In January 2020, the Company terminated the Second Lien Loan and Security Agreement.
2020 Notes
In April 2020, the Company entered into a Note Purchase Agreement and Convertible Promissory Notes (collectively the “2020 Notes Agreement”) with certain investors (the “Lenders”) to issue convertible promissory notes (the “2020 Notes”) for a maximum aggregate amount of $66.0 million. In April 2020, the Company received $33.0 million in gross proceeds from issuance of the 2020 Notes. Upon meeting customary closing conditions, the Company can draw up to an additional $33.0 million, provided that any such draw be for no less than $5.0 million on or prior to April 17, 2022. All unpaid interest and principal will be due and payable upon request of the majority of Lenders (“Majority Holders”) on or after the earlier of April 17, 2022 or an event of default. The 2020 Notes accrue interest at a rate equal to 2.0% above the Wall Street Journal Prime Rate. The Company may prepay the 2020 Notes prior to April 17, 2022 only with the consent of the Majority Holders.
In the event that the Company issued and sold shares of its convertible preferred stock to investors with total proceeds of not less than $30.0 million (excluding the conversion of the 2020 Notes or other convertible securities issued for capital raising purposes) (a “Qualified Financing”), then the outstanding principal amount of the 2020
F-29
Notes and any unpaid accrued interest should automatically convert into the same class and series of convertible preferred stock sold in the Qualified Financing at a conversion price equal to the lesser of (i) the price per share paid for preferred stock in the Qualified Financing multiplied by either 85% if the conversion took place within 18 months of the Initial Closing, or 80% otherwise, and (ii) $13.20 per share.
In the event the Company sold shares of convertible preferred stock in a transaction that did not constitute a Qualified Financing (a “Non-Qualified Financing”), then the Majority Holders would have the option to treat such Non-Qualified Financing as a Qualified Financing; provided, that, the Majority Holders might not elect to convert the 2020 Notes held by any Significant Holder in the Non-Qualified Financing without such Significant Holder’s consent unless such Non-Qualified Financing (a) was led by an investor who was not currently a stockholder of the Company and (ii) raised at least $10.0 million in total proceeds from investors who were not currently stockholders of the Company. A Significant Holder was a holder of the 2020 Notes equal to or greater than $20 million. If there was an event of default, then the conversion of the 2020 Notes would be at a conversion price equal to the lesser of:
a.the price per share paid for convertible preferred stock by the Investors in the Non-Qualified Financing multiplied by 75% , and
b.the Series G-1 convertible preferred stock conversion price of $13.20 per share multiplied by 75%.
Upon an initial public offering which resulted in net proceeds of not less than $30.0 million (a “Qualified IPO”), the outstanding 2020 Notes and any unpaid accrued interest should automatically convert in whole into shares of the Company’s common stock at a conversion price equal to the lesser of (i) price per share paid for common stock in the Qualified IPO multiplied by either 85% if the conversion took place within 18 months of the Initial Closing, or 80% otherwise, and (ii) $13.20 per share.
Upon an initial public offering that did not constitute a Qualified IPO (a “Non-Qualified IPO”), the Majority Holders should have the option to treat such Non-Qualified IPO as a Qualified IPO; provided that if there was an event of default, conversion of the 2020 Notes would be at a conversion price equal to the lesser of:
a.the price per share paid for common stock in the Non-Qualified IPO multiplied by 75%, and
b.the Series G- 1 convertible preferred stock conversion price of $13.20 per share multiplied by 75%.
At any other time upon the election of the Majority Holders or a Significant Holder, the outstanding principal amount of the 2020 Notes and any unpaid accrued interest would convert in whole into the Company’s Series G-1 convertible preferred stock at the Series G-1 convertible preferred stock conversion price of $13.20 per share. If there was an event of default prior to selection of such option, the 2020 Notes would be converted at a conversion price equal to the Series G-1 convertible preferred stock conversion price of $13.20 per share multiplied by 75%.
Upon any event of default, the Majority Holders could, at written notice to the Company, declare the principal and unpaid accrued interest under the 2020 Notes immediately due and payable.
The 2020 Notes included embedded derivatives that are required to be bifurcated from the 2020 Notes and accounted for separately as a single, compound embedded derivative instrument under ASC 815, Derivatives (“2020 Notes derivative liability”). The Company determined that the share settled redemption in the case of a financing or an IPO discussed above represented an embedded derivative that was not clearly and closely related to the debt host and had accounted for these settlement alternatives as separate embedded derivative liability. The fair value of the 2020 derivative liability of $3.9 million was recorded on the issuance date of the 2020 Notes resulting in a debt discount, which was reported as a direct deduction from the face amount of the 2020 Notes. The 2020 derivative liability was remeasured to its fair value at the end of each reporting period and any change in fair value was recognized in other income (expense), net in the statements of operations and comprehensive loss (Note 4). The change in fair value of $3.9 million during the year ended December 31, 2020 was recorded as a component of other income (expense), net in the condensed consolidated statements of operations and comprehensive loss. Upon the closing of the IPO in October 2020, the 2020 Notes converted pursuant to a qualified initial public offering. As a
F-30
result, the Company concluded that the 2020 Notes derivative had no value upon the closing of the IPO, because value of the notes with and without the such derivative was the same.
At December 31, 2020, the Company retained the ability to draw up to an additional $33.0 million under the 2020 Notes Agreement until the maturity date in April 2022. The Company’s obligations with respect to the 2020 Notes are unsecured and subordinated to its obligations with respect to the CIBC Loan. The 2020 Notes have customary events of default.
The Company incurred debt issuance costs of $0.1 million in connection with the 2020 Notes Agreement, which were reported on the balance sheet as a direct deduction from the face amount of the 2020 Notes.
During the year ended December 31, 2020, the Company recorded interest expense of $1.6 million on the 2020 Notes, consisting of $0.8 million of contractual interest expense and $0.8 million amortization of debt discount and debt issuance costs. Before the conversion upon the IPO, the 2020 Notes had an annual effective interest rate of 12.33% per year.
In connection with the closing of the IPO, the $33.0 million aggregate outstanding principal amount and $0.8 million accrued interest of the 2020 Notes converted into 2,561,484 shares of common stock at a conversion price of $13.20 per share.
Contractual Maturities of Financing Obligations
As of December 31, 2020, the aggregate future payments under the CIBC Loan and Credit Agreement (including interest payments) are as follows (in thousands):
| 2021 | 723 | ||||
| 2022 | 17,146 | ||||
| 2023 | — | ||||
| 2024 | — | ||||
| 2025 | 564 | ||||
| Total | 18,433 | ||||
| Less: unamortized debt discount | (196) | ||||
| Less: interest | (869) | ||||
Term loan, convertible notes, and credit agreement | $ | 17,368 | |||
7. Leases, Commitments and Contingencies
The Company has a lease for its headquarters location in Redwood City, California. In October 2019, the Company renewed its lease for the headquarters location in Redwood City, California for an additional five years commencing in August 2020 and expiring in July 2025. The monthly base rent during the renewed term is $0.1 million and is subject to an annual increase of 3.5%. The Company is responsible for its share of real estate taxes, common area maintenance and management fees. The Company is eligible to receive a tenant improvement allowance of $0.2 million on commencement of the renewal term in August 2020.
During 2013, the Company entered into a five-year lease for office facilities in Switzerland. The Company had an option to extend the lease through January 2022, which was not exercised by the Company. Per the lease terms, in the event the option to extend is not exercised, the lease remains in force and can be terminated with a 12-month’s notice.
F-31
In April 2020, the Company executed a sublease for another office facility in Redwood City, California for a three-year term commencing on June 1, 2020. The lease agreement provides for early termination if the Company or Sublandlord elects to terminate the lease by providing the other party at least 180 days prior written notice. The early termination may only occur on or after the expiration of the 18th full calendar month of the sublease term. The lease term for this lease is 18 months as the possible exercise of the early termination option by the Sublandlord is not within the Company’s control. The monthly base rent during the term is less than $0.1 million and is subject to an annual increase of 3.5%. The Company is responsible for its share of real estate taxes, common area maintenance and management fees.
In September 2020, the Company amended a sublease agreement entered in April 2020, to include additional facility space in Redwood City, California for a four-year term. The amendment was accounted as a separate sublease agreement. The sublease agreement contains a rent free period through February 14, 2021, after which rent is approximately $0.1 million per month and is subject to an annual increase of 3.5%. The Company is responsible for its share of real estate taxes, common area maintenance and management fees. The Company is eligible to receive a tenant improvement allowance of $0.6 million to fund facility enhancements. The sublease agreement can be extended for an additional month period, at the Company’s option. The lease term for this lease is 4 years as it is not reasonably certain that the Company will exercise the renewal option. The amendment also changed the lease term of sublease agreement entered in April 2020, which was extended until May 31, 2024, but left the early termination clause unchanged.
The Company has leases on two vehicle leases with lease terms ranging from 2 to 4 years.
Rent expense for the year ended December 31, 2018 under ASC 840 was $1.0 million.
Operating lease cost consists of the following (in thousands):
| Years Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
Operating lease cost | $ | 2,078 | $ | 1,037 | |||||||
Short-term lease cost | 12 | 13 | |||||||||
Variable lease cost | 337 | 234 | |||||||||
Total lease cost | $ | 2,427 | $ | 1,284 | |||||||
F-32
The following table summarizes a maturity analysis of our lease liabilities showing the aggregate lease payments as of December 31, 2020 (in thousands):
2021 | $ | 2,769 | |||
| 2022 | 2,069 | ||||
| 2023 | 2,795 | ||||
| 2024 | 2,589 | ||||
2025 | 1,007 | ||||
Total minimum lease payments | 11,229 | ||||
Less: Amount of lease payments representing interest | 1,373 | ||||
Present value of future minimum lease payments | $ | 9,856 | |||
Less: Current lease liabilities | $ | 2,238 | |||
Long-term lease liabilities | $ | 7,618 | |||
The following table summarizes balance sheet and other information related to our operating leases as (in thousands, except weighted average data):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
Right of use asset | $ | 8,976 | $ | 6,561 | |||||||
| Weighted average remaining lease term (years) | 4.13 | 5.54 | |||||||||
| Weighted average discount rate (percent) | 6.1 | 7.0 | |||||||||
The following table summarizes other supplemental information related to our operating leases (in thousands):
| Years Ended December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
Cash paid for amounts included in the measurement of lease liabilities included in cash flows used in operating activities | $ | 1,494 | $ | 893 | |||||||
Right-of-use assets obtained in exchange for lease liabilities | $ | 3,935 | $ | 7,316 | |||||||
Contingencies
From time to time, the Company may be a party to various litigation claims in the normal course of business. Legal fees and other costs associated with such actions are expensed as incurred. The Company assesses, in conjunction with legal counsel, the need to record a liability for litigation and contingencies. Accrual estimates are recorded when and if it is determinable that such a liability for litigation and contingencies are both probable and reasonably estimable.
In December 2018, a former distributor outside the United States filed suit alleging the Company’s subsidiary, PulmonX International Sàrl, conducted unfair competitive practices and violated the exclusive distribution rights as a result of the subsidiary’s termination of its distribution agreement. The complaint seeks pecuniary and non-pecuniary damages. The Company is in the initial stages of evaluating this matter and does not believe the impact of any such matter will be material to the Company’s results of operation or financial position.
F-33
8. Income Taxes
Income before the provision for income taxes consists of the following (in thousands):
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Domestic | $ | (28,029) | $ | (17,142) | $ | (12,527) | |||||||||||
| Foreign | (3,989) | (3,198) | (5,940) | ||||||||||||||
| Total loss before provision for taxes | $ | (32,018) | $ | (20,340) | $ | (18,467) | |||||||||||
The components of income tax expense are as follows (in thousands):
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Current: | |||||||||||||||||
| Federal | $ | — | $ | — | $ | — | |||||||||||
| State | 9 | 10 | 2 | ||||||||||||||
| Foreign | 185 | 358 | 207 | ||||||||||||||
| Total current expense | 194 | 368 | 209 | ||||||||||||||
| Deferred: | |||||||||||||||||
| Federal | 6 | 7 | (222) | ||||||||||||||
| State | 6 | 27 | 4 | ||||||||||||||
| Foreign | 7 | (39) | 21 | ||||||||||||||
| Total deferred expense | 19 | (5) | (197) | ||||||||||||||
| Total income tax expense | $ | 213 | $ | 363 | $ | 12 | |||||||||||
The reconciliation between the federal statutory rate and the Company’s effective tax rate is summarized below:
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Federal statutory rate | 21.0 | % | 21.0 | % | 21.0 | % | |||||||||||
| State taxes, net of federal benefit | 10.2 | % | 2.7 | % | 1.0 | % | |||||||||||
| Foreign earnings at different rates | (3.9) | % | (4.8) | % | (8.0) | % | |||||||||||
| Tax credits | 0.6 | % | 0.6 | % | 0.9 | % | |||||||||||
| Permanent differences | (0.3) | % | (0.4) | % | (0.3) | % | |||||||||||
| Prior year true-up | 0.3 | % | 0.0 | % | (2.9) | % | |||||||||||
| Change in valuation allowance | (40.5) | % | (20.9) | % | 10.7 | % | |||||||||||
| Expiration of net operating loss carryforwards and credits | 0.0 | % | 0.0 | % | (22.5) | % | |||||||||||
| Entity restructuring | 11.9 | % | 0.0 | % | 0.0 | % | |||||||||||
| Effective tax rate | (0.7) | % | (1.8) | % | (0.1) | % | |||||||||||
Deferred income taxes arise from temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax reporting purposes, as well as operating losses and
F-34
tax credit carryforwards. Significant components of the Company’s deferred tax assets and liabilities for federal and state income taxes are as follows (in thousands):
| December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Deferred tax assets: | |||||||||||||||||
| Net operating loss carryforwards | $ | 30,400 | $ | 22,500 | $ | 19,519 | |||||||||||
| Tax credit carryforwards | 5,240 | 4,896 | 4,659 | ||||||||||||||
| Other | 6,675 | 1,926 | 850 | ||||||||||||||
| Gross deferred tax assets | 42,315 | 29,322 | 25,028 | ||||||||||||||
| Less: valuation allowance | (41,922) | (28,953) | (24,736) | ||||||||||||||
| Deferred tax assets | 393 | 369 | 292 | ||||||||||||||
| Deferred tax liabilities: | |||||||||||||||||
| Depreciation | (27) | (23) | (17) | ||||||||||||||
| Goodwill | (428) | (389) | (323) | ||||||||||||||
| Net deferred tax liabilities | $ | (62) | $ | (43) | $ | (48) | |||||||||||
The Company has established a full valuation allowance against its U.S. net deferred tax assets due to the uncertainty surrounding the realization of such assets. Realization of deferred tax assets is dependent upon future earnings, if any, the timing and amount of which are uncertain. Accordingly, the U.S. net deferred tax assets have been fully offset by a valuation allowance of $41.9 million as of December 31, 2020. The valuation allowance increased by $13.0 million and $4.2 million and decreased by $2.0 million for the years ended December 31, 2020, 2019 and 2018, respectively.
As of December 31, 2020, the Company had total net operating loss carryforwards for federal income tax purposes of approximately $122.5 million. If not utilized, these net federal operating loss carryforwards will begin to expire at the end of the year. For tax years in January 1, 2018 onwards, any federal net operating losses generated will be allowable for carry forward indefinitely, as opposed to the original expiration of 20 years. As of December 31, 2020, the Company had $50.5 million of federal net operating losses that can be carryforward indefinitely. The Company also had a state net operating loss carryforward of approximately $90.3 million which will expire beginning in the year 2021.
The Company also had federal and state research and development (“R&D”) tax credit carryforwards of approximately $2.8 million and $4.2 million, respectively. The federal tax R&D credit carryforwards will expire beginning in 2030 while the state tax R&D credit carryforwards have no expiration date.
Utilization of the net operating loss carryforwards and R&D tax credit carryforwards may be subject to annual limitations due to the ownership change limitations provided by the Internal Revenue Code, as defined in Section 382, and other similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. During the year ended December 31, 2018, the Company completed a formal 382 study for which the Company wrote off deferred tax assets for NOLs and credits of $3.1 million and $1.2 million, respectively. Since the Company had a full valuation allowance on these assets, there was no material impact to the tax provision. The Company completed another section 382 study for the year ended December 31, 2020 for which the Company had a change in ownership. No additional NOLs or credits will expire unused due to the 2020 annual limitation.
Annually, the Company determines whether it is “more likely than not” that a tax position will be sustained upon examination by the appropriate taxing authorities in considering whether any tax benefit can be recorded in the consolidated financial statements. As of December 31, 2020, the Company had unrecognized tax benefits of approximately $8.2 million, none of which will affect the tax rate if recognized. It is unlikely that the amount of liability for unrecognized tax benefits will significantly change over the next 12 months.
F-35
The following table summarizes the activity related to the Company’s gross unrecognized tax benefits (in thousands):
| Balance at December 31, 2017 | $ | 1,070 | |||
| Additions for tax positions related to current year | 57 | ||||
| Reductions for tax positions related to prior year | (185) | ||||
| Balance at December 31, 2018 | $ | 942 | |||
Additions for tax positions related to current year | 47 | ||||
| Additions for tax positions related to prior year | — | ||||
| Balance at December 31, 2019 | $ | 989 | |||
Additions for tax positions related to current year | 7,259 | ||||
| Additions for tax positions related to prior year | — | ||||
| Balance at December 31, 2020 | $ | 8,248 | |||
It is the Company’s policy to include penalties and interest expense related to income taxes as part of the provision for income taxes.
The Company’s major tax jurisdictions are the United States and California, Switzerland and Neuchâtel, and Grand Cayman. All of the Company’s tax years will remain open for examination by the federal and state tax authorities for three and four years, respectively, from the date of utilization of the net operating loss or R&D Credits. The Company does not have any tax audits or other issues pending.
On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act was enacted and signed into law. The CARES Act, among other things, includes provisions related to refundable payroll tax credits, deferment of employer side social security payments, net operating loss carryback periods and technical corrections to tax depreciation methods for qualified improvement property.
There were no impacts in the current year as a result of the CARES Act. The Company will continue to examine the elements of the CARES Act for any impact they may have on the Company’s future business
9. Warrants for Convertible Preferred Stock
A summary of the outstanding convertible preferred stock warrants is as follows (in thousands, except per share and share amounts):
| December 31, 2019 | ||||||||||||||||||||||||||
Exercise Price Per share | Shares | Fair Value of Liability | Expiration Date | |||||||||||||||||||||||
| Series C-1 convertible preferred stock warrants | $ | 10.57 | 215,291 | $ | — | February 9, 2020 | ||||||||||||||||||||
Series C-1 Convertible Preferred Stock Warrants
In February 2018, warrants to purchase 7,884 shares of Series C-1 convertible preferred stock were exercised at an exercise price of $10.57 per share, yielding $0.1 million. Pursuant to the February 2018 warrant amendment, shares issuable upon exercise of the warrants decreased from 430,588 to 215,291.
The Company revalued the remaining warrants at December 31, 2019 and December 31, 2018, and recorded income of less than $0.1 million and expense of less than $0.1 million, respectively, in change in other income (expense), net in the consolidated statements of operations and comprehensive loss for the years ended December 31, 2019 and 2018, respectively.
F-36
In January and February 2020, warrants to purchase 213,876 shares of Series C-1 convertible preferred stock were exercised at an exercise price of $10.57 per share, yielding $2.3 million cash proceeds and warrants to purchase 1,415 shares of Series C-1 convertible preferred stock warrants expired.
10. Convertible Preferred Stock
Under the Company’s Amended and Restated Certificate of Incorporation, the Company is authorized to issue 0 shares of convertible preferred stock.
In April 2019, the Company issued 3,030,296 shares of Series G-1 convertible preferred stock at a price of $13.20 per share for cash proceeds of approximately $40.0 million. Additionally, the Company issued 1,903,935 shares of Series G-1 convertible preferred stock at a price of $13.20 per share upon the conversion of $25.1 million of convertible promissory notes and accrued interest with Boston Scientific Corporation (Note 6).
Upon the closing of the IPO in October 2020, all outstanding shares of the convertible preferred stock converted into 17,797,026 shares of common stock and the related carrying value was reclassified to common stock and additional paid-in capital. There was no issued and outstanding convertible preferred stock as of December 31, 2020.
As of December 31, 2019, convertible preferred stock consists of the following (in thousands, except per share and share amounts):
| Series | Number of Shares Authorized | Number of Shares Issued and Outstanding | Carrying Value(1) | Liquidation Preference per Share | Liquidation Value | |||||||||||||||||||||||||||
| Series A-1 | 8,486,224 | 848,595 | $ | 8,135 | $ | 9.59 | $ | 8,138 | ||||||||||||||||||||||||
| Series B-1 | 24,224,676 | 2,422,444 | 23,130 | 10.57 | 25,605 | |||||||||||||||||||||||||||
| Series C-1 | 39,422,980 | 3,726,974 | 37,306 | 10.57 | 39,395 | |||||||||||||||||||||||||||
| Series D-1 | 9,400,000 | 939,979 | 10,268 | 11.00 | 10,340 | |||||||||||||||||||||||||||
| Series E-1 | 9,230,768 | 923,049 | 11,896 | 13.00 | 12,000 | |||||||||||||||||||||||||||
| Series F-1 | 37,878,787 | 3,787,878 | 49,800 | 13.20 | 50,000 | |||||||||||||||||||||||||||
| Series G-1 | 49,342,376 | 4,934,231 | 64,804 | 13.20 | 65,132 | |||||||||||||||||||||||||||
| Total | 177,985,811 | 17,583,150 | $ | 205,339 | $ | 210,610 | ||||||||||||||||||||||||||
_______________
(1)Carrying values above are net of issuance costs.
Dividends
The holders of Series A-1, Series B-1, Series C-1, Series D-1, Series E-1, Series F-1 and Series G-1 convertible preferred stock are entitled to receive dividends, out of any assets legally available, prior and in preference to any declaration or payment of any dividend on the common stock of the Company, at a rate of $0.7672, $0.8456, $0.8456, $0.88, $1.04, $1.056 and $1.056 respectively, per share per year (as adjusted for stock splits, stock dividends, reclassifications and similar events) payable quarterly when, and as declared by the Board of Directors and are not cumulative. After payment of such dividends, any additional dividends shall be distributed the holders of Series A-1, Series B-1, Series C-1, Series D-1, Series E-1, Series F-1 and Series G-1 convertible preferred stock and common stock on a pro rata basis. No dividends have been declared to date.
Liquidation
In the event of any liquidation, dissolution or winding up of the Company, either voluntary or involuntary, the holders of Series G-1 convertible preferred stock shall be entitled to receive, prior and in preference to any distribution of the assets of the Corporation or any such consideration to the holders of Series A-1, Series B-1, Series C-1, Series D-1, Series E-1 and Series F-1 convertible preferred stock or the holders of common stock, an amount
F-37
equal to $13.20 per share (as adjusted for stock splits, stock dividends, reclassification and similar events) plus any declared but unpaid dividends. If upon the occurrence of such event, the assets and funds available are insufficient to permit the payment to the Series G-1 convertible preferred stockholders of the full preferential amounts, then the entire assets and funds of the Company legally available for distribution shall be distributed ratably among the holders of Series G-1 convertible preferred stock in proportion to the preferential amount each such holder is otherwise entitled to receive. After the payment in full of the Series G-1 liquidation preference, the holders of Series F-1 convertible preferred stock shall be entitled to receive, prior and in preference to any distribution of the assets of the Corporation or any such consideration to the holders of Series A-1, Series B-1, Series C-1, Series D-1 and Series E-1 convertible preferred stock or the holders of common stock, an amount equal to $13.20 per share (as adjusted for stock splits, stock dividends, reclassification and similar events) plus any declared but unpaid dividends. If upon the occurrence of such event, the assets and funds available are insufficient to permit the payment to the Series F-1 convertible preferred stockholders of the full preferential amounts, then the entire assets and funds of the Company legally available for distribution shall be distributed ratably among the holders of Series F-1 convertible preferred stock in proportion to the preferential amount each such holder is otherwise entitled to receive. After the payment in full of the Series F-1 liquidation preference, the holders of the Series E-1 convertible preferred stock shall be entitled to receive, prior and in preference to any distribution of the assets of the Corporation or any such consideration to the holders of Series A-1, Series B-1, Series C-1, and Series D-1 convertible preferred stock or the holders of common stock, an amount equal to $13.00 per share (as adjusted for stock splits, stock dividends, reclassification and similar events) plus any declared but unpaid dividends. If upon the occurrence of such event, after payment in full of the Series F-1 liquidation preference, the assets and funds available are insufficient to permit the payment to the Series E-1 convertible preferred stockholders of the full preferential amounts, then the entire assets and funds of the Company legally available for distribution shall be distributed ratably among the holders of Series E-1 convertible preferred stock in proportion to the preferential amount each such holder is otherwise entitled to receive. After the payment in full of the Series F-1 liquidation preference and the Series E-1 liquidation preference, the holders of Series A-1, Series B-1, Series C-1 and Series D-1 convertible preferred stock are entitled to receive, prior and in preference to any distribution of the assets of the Corporation or any such consideration to the holders of common stock, an amount equal to $9.59, $10.57, $10.57 and $11.00 per share (as adjusted for stock splits, stock dividends, reclassification and similar events) plus any declared but unpaid dividends. If upon the occurrence of such liquidation, the assets and funds of the Company legally available for distribution are insufficient to permit payment to such holders, then the entire remaining assets and funds shall be distributed ratably among such holders in proportion to the preferential amounts each such holder is otherwise entitled to receive.
In the event of a Liquidation Transaction involving one or more third parties other than the purchaser of Series F-1 convertible preferred stock and after the payment in full of the liquidation preference required to be paid, the holders of the Series F-1 convertible preferred stock shall be entitled to receive, prior and in preference to any distribution of any of the assets of the Company or any such consideration to the holders of common stock an amount equal to the Additional Preference (as defined below) for each share of Series F-1 preferred stock then held by them. Upon the closing of a Liquidation Transaction, if the amounts earned or payable to the stockholders of the Corporation on or before the one (1) year anniversary of the closing of such Liquidation Transaction is (i) equal to or greater than $250.0 million but less than $300.0 million, the Additional Preference is equal to $3.30 per share (as adjusted for stock splits, stock dividends, reclassifications and the like) for each share of Series F-1 convertible preferred stock then held by them, (ii) equal to or greater than $300.0 million but less than $350.0 million, the Additional Preference is equal to $5.00 per share (as adjusted for stock splits, stock dividends, reclassifications and the like) for each share of Series F-1 preferred stock then held by them, and (iii) equal to or greater than $350.0 million, the Additional Preference is equal to $6.60 per share (as adjusted for stock splits, stock dividends, reclassifications and the like) for each share of Series F-1 convertible preferred stock then held by them.
After liquidation preferences to the convertible preferred stockholders have been paid, and after the Additional Preference has been paid, if any, the remaining assets of the Company shall be distributed to the holders of common stock, Series A-1, Series B-1, Series C-1, Series D-1, Series E-1, Series F-1 and Series G-1 convertible preferred stock as if the convertible preferred shares were converted into common stock at then-applicable conversion price until the Series A-1, Series B-1, Series C-1, Series D-1, Series E-1, Series F-1 and Series G-1 convertible preferred stock have received an aggregate amount (including the initial preference amount) equal to $28.77, $31.71, $31.71, $33.00, $39.00, $39.60 and $39.60 per share (as adjusted for stock splits, stock dividends, reclassifications and
F-38
similar events) plus any declared and unpaid dividends. The holders of common stock are entitled to receive ratably on a per-share basis all remaining assets.
A liquidation, dissolution or winding up of the Company shall be deemed to be occasioned by, or include, (A) the sale, lease, license on an exclusive basis, conveyance or disposition (whether by merger or otherwise) by the Company of all or substantially all of the assets of the Company, or the sale or disposition of one or more subsidiaries of the Company if substantially all of the assets of the Company and its subsidiaries taken as a whole are held by such subsidiary or subsidiaries, or (B) the merger of the Company with or into any other corporation, limited liability company or other entity (other than a wholly-owned subsidiary of the Company); provided that none of the following shall be considered a Liquidation Transaction: (i) a merger effected exclusively for the purpose of changing the domicile of the Company, (ii) an equity financing effected for bona fide capital raising purposes in which the Company is the surviving entity or (iii) any transaction in which the stockholders of the Company immediately prior to the transaction own greater than 50% of the voting power of the Company or such other surviving or resulting entity (or if the Company or such other surviving or resulting entity is a wholly-owned subsidiary immediately following such acquisition, its parent).
Voting
The holders of convertible preferred stock shall have the same voting rights as the holders of common stock. The holders of common stock and the convertible preferred stock shall vote together as a single class on all matters. Each holder of common stock shall be entitled to one vote for each share of common stock held, and each holder of convertible preferred stock shall be entitled to the number of votes equal to the number of shares of common stock into which such shares of convertible preferred stock could be converted.
As of December 31, 2020, the Board of Directors was comprised of seven members. For so long as there are outstanding at least 50,000 shares of Series A-1 convertible preferred stock (as adjusted for stock splits, reclassifications or similar events), the holders of Series A-1 convertible preferred stock, voting as a separate class, shall be entitled to elect one member of the Company’s Board of Directors. For so long as there are outstanding at least 50,000 shares of Series B-1 convertible preferred stock (as adjusted for stock splits, reclassifications or similar events), the holders of Series B-1 convertible preferred stock, voting as a separate class, shall also be entitled to elect two members of the Company’s Board of Directors. For so long as there are outstanding at least 50,000 shares of Series C-1 convertible preferred stock (as adjusted for stock splits, reclassifications or other similar transactions), the holders of Series C-1 convertible preferred stock, voting as a separate class, shall be entitled to elect two members of the Company’s Board of Directors. For so long as there are outstanding at least 50,000 shares of Series G-1 convertible preferred stock (as adjusted for stock splits, reclassifications or other similar transactions), the holders of Series G-1 convertible preferred stock, voting as a separate class, shall be entitled to elect one member of the Company’s Board of Directors. The holders of common stock and convertible preferred stock, voting together as a single class on an as-if-converted basis, shall be entitled to elect all remaining members of the Board of Directors.
Conversion
Each share of convertible preferred stock shall be convertible, at the option of the holder at any time after the date of issuance into the number of fully paid and non-assessable shares of common stock as determined by dividing the original issue price per share of each series of convertible preferred stock by the conversion price per share in effect for the shares of each series of convertible preferred stock at the time of conversion. The original conversion price per share of Series A-1, Series B-1, Series C-1, Series D-1, Series E-1, Series F-1 and Series G-1 convertible preferred stock shall be the original issue price, subject to adjustment, as described in the Company’s Amended and Restated Certificate of Incorporation.
Each share of convertible preferred stock shall automatically be converted into shares of common stock at the conversion rate at the time in effect for such share immediately upon the earlier of (i) the Company’s sale of its common stock in a firm commitment underwritten public offering pursuant to a registration statement under the Securities Act of 1933 (“IPO”) which results in aggregate cash proceeds to the Company of not less than $30.0 million (net of underwriting discounts and commissions) (“Qualified IPO”) or (ii) the date specified by the vote or
F-39
written consent of the holders of at least a majority of the then outstanding shares of convertible preferred stock, voting together as a single class. However, if the offering price to the public in a Qualified IPO (“Public Offering Price”) is less than 1.15 times of the conversion price of the Series G-1 convertible preferred stock in effect immediately prior to the Qualified IPO, then the conversion price for the Series G-1 convertible preferred stock shall be adjusted such that, upon the closing of the Qualified IPO, each share of Series G-1 convertible preferred stock will convert into that number of shares of common stock equal to the sum of (a) the number of shares of common stock issuable upon conversion of such share of Series G-1 convertible preferred stock immediately prior to the Qualified IPO (the “Pre-IPO Shares”) and (b) an additional number of shares of common stock determined by multiplying the Pre-IPO Shares by the quotient of (x) the difference between 1.15 times the conversion price of the Series G-1 convertible preferred stock immediately prior to the Qualified IPO and the Public Offering Price, divided by (y) the Public Offering Price.
11. Stockholders’ Equity (Deficit)
Common Stock
As of December 31, 2020 and December 31, 2019, the Company’s certificate of incorporation authorized the Company to issue up to 200,000,000 and 240,000,000 shares of common stock, respectively. Common stockholders are entitled to dividends as and when declared by the Board of Directors, subject to the rights of holders of all classes of stock outstanding having priority rights as to dividends. There have been no dividends declared to date. The holder of each share of common stock is entitled to one vote. The Company constructively retired 414 shares of common stock during the year that were abandoned.
Shares Reserved for Future Issuance
The Company has reserved shares of common stock for future issuances as follows:
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
Series A-1 convertible preferred stock outstanding | — | 848,595 | |||||||||
Series B-1 convertible preferred stock outstanding | — | 2,422,444 | |||||||||
Series C-1 convertible preferred stock outstanding | — | 3,726,974 | |||||||||
Series D-1 convertible preferred stock outstanding | — | 939,979 | |||||||||
Series E-1 convertible preferred stock outstanding | — | 923,049 | |||||||||
Series F-1 convertible preferred stock outstanding | — | 3,787,878 | |||||||||
Series G-1 convertible preferred stock outstanding | — | 4,934,231 | |||||||||
Warrants to purchase Series C-1 convertible preferred stock | — | 215,291 | |||||||||
Common stock options issued and outstanding | 2,923,403 | 3,279,324 | |||||||||
Common stock available for future grants | 3,233,794 | 77,603 | |||||||||
| Common stock available for ESPP | 720,000 | — | |||||||||
| Total | 6,877,197 | 21,155,368 | |||||||||
Stock Option Plan
As of December 31, 2020, the Company reserved 9,842,151 shares of its common stock under its 2000 Stock Plan (the “2000 Stock Plan”), the 2010 Stock Plan (the “2010 Stock Plan”), the 2020 Stock Plan (the “2020 Stock Plan”), and the 2020 Equity Incentive Plan (the “2020 Equity Incentive Plan” and, together with the 2000 Stock Plan, the 2010 Stock Plan and the 2020 Stock Plan, the “Stock Plans”). Options granted under the Stock Plans may be either incentive stock options or nonqualified stock options. Incentive stock options (“ISO”) may be granted only to the
F-40
Company employees (including officers and directors). Nonqualified stock options (“NSO”) may be granted to the Company employees and consultants. As of December 31, 2020 and December 31, 2019, no shares of common stock remain available for issuance to officers, directors, employees and consultants pursuant to the 2000 Stock Plan.
Options to purchase the Company’s common stock may be granted at a price not less than 100% of the fair market value in the case of ISO or NSO, except for an employee or non-employee with options who owns more than 10% of the voting power of all classes of stock of the Company in which case the exercise price shall be no less than 110% of the fair market value per share on the grant date. Fair market value is determined by the Board of Directors. Options are immediately exercisable and vest as determined by the Board of Directors ranging from immediately upon grant to a rate of 25% per annum over four years from the grant date. Options expire as determined by the Board of Directors but not more than ten years after the date of grant.
Activity under the Stock Plans is set forth below:
Outstanding Options | |||||||||||||||||
| Shares Available for Grant | Number of Shares | Weighted Average Exercise Price | |||||||||||||||
| Balance, January 1, 2018 | 125,199 | 2,419,948 | $ | 1.52 | |||||||||||||
| Additional shares reserved | 502,179 | — | $ | — | |||||||||||||
| Options granted | (255,900) | 255,900 | $ | 1.37 | |||||||||||||
| Options exercised | — | (18,153) | $ | 1.68 | |||||||||||||
Options canceled(1) | 11,201 | (31,201) | $ | 1.53 | |||||||||||||
| Balance, December 31, 2018 | 382,679 | 2,626,494 | $ | 1.51 | |||||||||||||
Additional shares reserved | 738,572 | — | — | ||||||||||||||
Options granted | (1,078,957) | 1,078,957 | 1.93 | ||||||||||||||
Options exercised | — | (390,318) | 1.35 | ||||||||||||||
Options canceled(1) | 35,309 | (35,809) | 1.39 | ||||||||||||||
| Balance, December 31, 2019 | 77,603 | 3,279,324 | $ | 1.66 | |||||||||||||
Additional shares reserved | 4,553,378 | — | — | ||||||||||||||
Options granted | (1,466,071) | 1,466,071 | 7.73 | ||||||||||||||
Options exercised | — | (1,745,040) | 1.55 | ||||||||||||||
Options canceled(1) | 68,884 | (76,952) | 3.55 | ||||||||||||||
| Balance, December 31, 2020 | 3,233,794 | 2,923,403 | $ | 4.72 | |||||||||||||
______________
(1)Canceled stock options issued under the Company’s 2000 Stock Plan were canceled after the 2010 Stock Plan was approved and are not included in the shares available for grant as they were not returned to the stock option pool.
The aggregate intrinsic value of options exercised during the years ended December 31, 2020, December 31, 2019 and December 31, 2018 was $2.0 million, $0.2 million and less than $0.1 million, respectively.
The weighted average exercise price and aggregate intrinsic value of options outstanding at December 31, 2020 was $4.72 per share and $188.0 million, respectively. The weighted average exercise price and aggregate intrinsic value of options outstanding at December 31, 2019 was $1.66 per share and $10.9 million, respectively. The aggregate intrinsic value is calculated as the difference between the exercise price of the underlying stock options and the fair
F-41
value of the Company’s common stock for stock options that were in-the-money as of December 31, 2020 and December 31, 2019.
| December 31, 2020 | |||||||||||||||||
Number of Shares | Weighted Average Exercise Price | Weighted Average Contractual Life (in Years) | |||||||||||||||
| Options vested | 1,219,241 | $ | 2.03 | 5.23 | |||||||||||||
| Options vested and expected to vest | 2,923,403 | $ | 4.72 | 7.63 | |||||||||||||
Total intrinsic value of options vested as of December 31, 2020 and December 31, 2019 was $81.7 million and $7.6 million, respectively.
Early Exercise of Stock Options
Under the terms of the individual option grants, all options are fully exercisable on the grant date, subject to the Company’s repurchase right at the original exercise price. Accordingly, options may be exercised prior to vesting. The shares are subject to the Company’s lapsing repurchase right upon termination of employment or over the options’ vesting period of generally four years at the original purchase price. The proceeds initially are recorded in other liabilities from the early exercise of stock options and are reclassified to additional paid-in capital as the Company’s repurchase right lapses. During the year ended December 31, 2020 and 2019, the Company repurchased 10,000 and 9,147 shares of common stock for less than $0.1 million and less than $0.1 million, respectively. As of December 31, 2020 and December 31, 2019, 355,677 and 199,810 shares were subject to repurchase, with an aggregate exercise price of $0.6 million and $0.3 million, respectively, and were recorded in other current liabilities.
Stock-Based Compensation for Employees and Non-Employees
During the years ended December 31, 2020, December 31, 2019 and December 31, 2018, the Company granted stock options to employees and non-employees to purchase 1,466,071, 1,078,957 and 255,900 shares of common stock, respectively. The weighted average grant-date fair value of the stock options granted during the years ended December 31, 2020, December 31, 2019 and December 31, 2018 was $3.78, $1.79 and $0.70 per share, respectively.
The Company uses the Black-Scholes Merton option-pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant is affected by the stock price as well as assumptions regarding a number of complex and subjective variables. These variables include expected stock price volatility over the term of the awards, actual and projected employee stock option exercise behaviors, risk-free interest rates and expected dividends. The estimated grant date fair values of employee stock options were calculated using the following assumptions:
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Weighted average expected term (in years) | 5.0 - 6.1 | 5.3 - 6.1 | 6.3 | ||||||||||||||
| Volatility | 40.0% - 44.7% | 47.1% - 49.7% | 46.0% | ||||||||||||||
| Risk-free interest rate | 0.2% - 1.7% | 1.4% - 1.8% | 2.4%-2.9% | ||||||||||||||
| Dividend yield | — | — | — | ||||||||||||||
Expected Term
The expected term is calculated using the simplified method, which is available where there is insufficient historical data about exercise patterns and post-vesting employment termination behavior. The simplified method is based on the vesting period and the contractual term for each grant, or for each vesting-tranche for awards with graded vesting. The mid-point between the vesting date and the maximum contractual expiration date is used as the
F-42
expected term under this method. For awards with multiple vesting-tranches, the periods from grant until the mid-point for each of the tranches are averaged to provide an overall expected term.
Volatility
The expected stock price volatility assumptions for the Company’s stock options for the years ended December 31, 2020, December 31, 2019 and December 31, 2018 was determined by examining the historical volatilities for industry peers, referred to as “guideline” companies, as the Company did not have any trading history for the Company’s common stock. In evaluating similarity, the Company considered factors such as industry, stage of life cycle and size.
Risk-Free Rate
The risk-free interest rate assumption is based on the U.S. Treasury instruments whose term was consistent with the expected term of the Company’s stock options.
Dividend Yield
The expected dividend assumption is based on the Company’s history and expectation of dividend payouts.
Fair Value of Common Stock
Prior to the IPO the fair value of the Company’s common stock is determined by the board of directors with assistance from management and, in part, on input from an independent third-party valuation firm. The board of directors determines the fair value of common stock by considering a number of objective and subjective factors, including valuations of comparable companies, sales of convertible preferred stock, operating and financial performance, the lack of liquidity of the Company’s common stock and the general and industry-specific economic outlook. Subsequent to the Company’s IPO, the fair value of the Company’s common stock is determined based on its closing market price.
2020 Employee Share Purchase Plan
In September 2020, the Company adopted the 2020 Employee Share Purchase Plan (“ESPP”), which became effective on the business day prior to the effectiveness of the registration statement relating to the IPO. A total of 720,000 shares of common stock were initially reserved for issuance under the ESPP. The ESPP permits eligible employees to acquire shares of the Company’s common stock through periodic payroll deductions of up to 15% of base compensation. No employee may purchase more than 2,500 shares during an offering period. In addition, no employee may purchase more than $25,000 worth of stock, determined by the fair market value of the shares at the time such option is granted, in one calendar year. The ESPP provides for an offering period from September 30, 2020 until May 24, 2021 with the purchase date of last date of offering period. At the end of each purchase period, employees are able to purchase shares at 85% of the lower of the fair market value of the Company’s common stock on the first trading day of the offering period or on the last trading day of the offering period.
The Company issued no shares under the ESPP for the year ended December 31, 2020. Shares authorized for future purchase under the ESPP were 720,000 at December 31, 2020. In January 2021, the number of shares of common stock available for issuance under the ESPP was increased by 356,937 shares as a result of the automatic increase provision in the ESPP.
Compensation expense is calculated using the fair value of the employees' purchase rights under the Black-Scholes model.
F-43
| Year Ended | |||||
| December 31, 2020 | |||||
| Weighted average expected term (in years) | 0.6 | ||||
| Volatility | 67.7% - 68.2% | ||||
| Risk-free interest rate | 0.1% | ||||
| Dividend yield | — | ||||
Total Stock-Based Compensation
Stock-based compensation expense is reflected in the statements of operations and comprehensive loss as follows (in thousands):
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Cost of goods sold | $ | 39 | $ | 30 | $ | 18 | |||||||||||
| Research and development | 398 | 64 | 62 | ||||||||||||||
| Selling, general and administrative | 2,760 | 270 | 286 | ||||||||||||||
| Total | $ | 3,197 | $ | 364 | $ | 366 | |||||||||||
The above stock-based compensation expense related to the following equity-based awards:
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Stock options | $ | 2,055 | $ | 364 | $ | 366 | |||||||||||
| ESPP | 1,142 | — | — | ||||||||||||||
| Total | $ | 3,197 | $ | 364 | $ | 366 | |||||||||||
Stock-based compensation of $0.3 million, $0 and $0 was capitalized into inventory for the years ended December 31, 2020, 2019, and 2018, respectively. Capitalized stock-based compensation is recognized as cost of sales when the related product is sold.
As of December 31, 2020, there was $14.8 million of unrecognized compensation costs related to non-vested common stock options, expected to be recognized over a weighted-average period of 2.28 years, respectively. The total grant date fair value of shares vested during the years ended December 31, 2020, December 31, 2019 and December 31, 2018 was $1.9 million, $0.3 million and $0.4 million, respectively.
As of December 31, 2020, the Company had unrecognized employee stock-based compensation relating to ESPP awards of approximately $2.3 million, which is expected to be recognized over a weighted-average period of 0.4 years.
F-44
12. Net Loss per Share Attributable to Common Stockholders
The following table sets forth the computation of basic and diluted net loss per share attributable to common stockholders which excludes shares which are legally outstanding, but subject to repurchase by the Company (in thousands, except share and per share amounts):
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Numerator | |||||||||||||||||
| Net loss attributable to common stockholders | $ | (32,231) | $ | (20,703) | $ | (18,479) | |||||||||||
| Denominator | |||||||||||||||||
| Weighted-average common stock outstanding | 10,341,809 | 1,796,233 | 1,706,654 | ||||||||||||||
| Less: weighted-average common shares subject to repurchase | (156,968) | (20,123) | (31,875) | ||||||||||||||
Weighted-average common shares used to compute basic and diluted net loss per share | 10,184,841 | 1,776,110 | 1,674,779 | ||||||||||||||
| Net loss per share attributable to common stockholders, basic and diluted | $ | (3.16) | $ | (11.66) | $ | (11.03) | |||||||||||
The following potentially dilutive securities outstanding have been excluded from the computation of diluted weighted average shares outstanding because such securities have an antidilutive impact due to the Company’s net loss, in common stock equivalent shares:
| Years Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| Convertible preferred stock | — | 17,583,150 | 12,648,919 | ||||||||||||||
| Convertible preferred stock warrants | — | 215,291 | 215,291 | ||||||||||||||
| Options to purchase common stock | 2,923,403 | 3,279,324 | 2,626,494 | ||||||||||||||
| Unvested early exercised common stock options | 355,677 | 199,810 | 26,852 | ||||||||||||||
| Shares committed under ESPP | 47,174 | — | — | ||||||||||||||
| Conversion of convertible notes* | — | — | — | ||||||||||||||
______________
*At December 31, 2018, the conversion of the convertible notes into convertible preferred stock was dependent on the outstanding loan balance including accrued interest and the conversion stock per share price at the date of Qualified Equity Financing, Change of Control, Liquidation, or Prepayment Conversion (see Note 6). These factors were not estimable and the number of convertible preferred stock was not determinable. These convertible notes converted to Series G-1 convertible preferred in April 2019 (Note 10).
13. Segment Information
The chief operating decision maker for the Company is the Chief Executive Officer. The Company’s Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by information about revenue by geographic region, for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations, operating results or plans for levels or components below the consolidated unit level. Accordingly, the Company has determined that it has a single reportable and operating segment structure. The Company’s Chief Executive Officer evaluates performance based primarily on revenue in the geographic locations in which the Company operates.
F-45
Revenue by geographic area is based on the billing address of the customer. The following table sets forth our revenue by geographic area (in thousands):
| Year Ended December 31, | |||||||||||||||||
| 2020 | 2019 | 2018 | |||||||||||||||
| United States | $ | 16,189 | $ | 10,704 | $ | 563 | |||||||||||
| Europe, Middle-East and Africa | 13,808 | 18,364 | 16,175 | ||||||||||||||
| Asia Pacific | 2,687 | 3,227 | 3,115 | ||||||||||||||
| Other International | 49 | 300 | 151 | ||||||||||||||
| Total | $ | 32,733 | $ | 32,595 | $ | 20,004 | |||||||||||
Revenue from Germany represented 17%, 22%, and 37% of total revenue for the years ended December 31, 2020, 2019, and 2018, respectively.
Long-lived assets by geographic area are based on physical location of those assets. The following table sets forth our long-lived assets by geographic area (in thousands):
| December 31, | |||||||||||
| 2020 | 2019 | ||||||||||
| United States | $ | 1,437 | $ | 852 | |||||||
| Europe, Middle-East and Africa | 29 | 40 | |||||||||
| Asia Pacific | 8 | 10 | |||||||||
| Total | $ | 1,474 | $ | 902 | |||||||
14. Employee Benefit Plan
Effective October 1997, the Company implemented a retirement savings plan (the “Savings Plan”) which is intended to qualify as a deferred savings plan under Section 401(k) of the Internal Revenue Code. Participants are allowed to contribute up to 100% of the total compensation, not to exceed the amount allowed by the applicable statutory prescribed limit. There have been no contributions made to the Savings Plan by the Company since inception.
15. Related Parties
Since October 2013, the Company has received services from the chairman of a subsidiary of the Company. During 2014, this person served as Interim CEO and was appointed to the Board of Directors of the Company. Amounts paid related to consulting services for the years ended December 31, 2020, December 31, 2019 and December 31, 2018 was less than $0.1 million, $0.1 million and $0.1 million, respectively.
See Note 6 for details regarding the Company’s Second Lien Loan and Security Agreement with Boston Scientific Corporation.
16. Selected Quarterly Financial Data (unaudited)
The following table provides the selected quarterly financial information for the years 2020 and 2019 (in thousands, except per share data):
F-46
| Three months ended | |||||||||||||||||||||||
| March 31, 2020 | June 30, 2020 | September 30, 2020 | December 31, 2020 | ||||||||||||||||||||
| Revenue | $ | 8,618 | $ | 3,673 | $ | 10,612 | $ | 9,830 | |||||||||||||||
| Gross profit | $ | 5,650 | $ | 1,012 | $ | 7,462 | $ | 7,078 | |||||||||||||||
| Net loss | $ | (7,163) | $ | (11,911) | $ | (3,860) | $ | (9,297) | |||||||||||||||
| Net loss per share attributable to common stockholders, basic and diluted | $ | (3.76) | $ | (6.15) | $ | (1.37) | $ | (0.27) | |||||||||||||||
| Three months ended | |||||||||||||||||||||||
| March 31, 2019 | June 30, 2019 | September 30, 2019 | December 31, 2019 | ||||||||||||||||||||
| Revenue | $ | 5,778 | $ | 7,366 | $ | 9,104 | $ | 10,347 | |||||||||||||||
| Gross profit | $ | 3,717 | $ | 4,953 | $ | 6,407 | $ | 7,337 | |||||||||||||||
| Net loss | $ | (6,128) | $ | (5,571) | $ | (4,335) | $ | (4,669) | |||||||||||||||
| Net loss per share attributable to common stockholders, basic and diluted | $ | (3.61) | $ | (3.24) | $ | (2.41) | $ | (2.48) | |||||||||||||||
17. Subsequent Events
Subsequent to December 31, 2020, the Company granted 6,300 restricted stock units and options to purchase 8,600 shares of common stock to employees, subject to service-based vesting conditions. The options have a weighted-average exercise price of $62.34 per share.
F-47
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
None.
ITEM 9A. CONTROLS AND PROCEDURES
Management’s Evaluation of our Disclosure Controls and Procedures
We maintain “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms and accumulated and communicated to our management, including our principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based upon such evaluation, management concluded that the design and operation of our disclosure controls and procedures were effective at a reasonable assurance level as of December 31, 2020.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting during the quarter ended December 31, 2020, that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control over Financial Reporting
This Annual Report on Form 10-K does not include a report of management’s assessment regarding internal control over financial reporting or an attestation report of our independent registered public accounting firm due to a transition period established by the rules of the SEC for newly public companies.
ITEM 9B. OTHER INFORMATION
None.
148
PART III
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this item will be contained in our definitive proxy statement to be filed with the SEC in connection with the Annual Meeting of Stockholders within 120 days after December 31, 2020, or the Proxy Statement, and is incorporated in this Annual Report on Form 10-K by reference.
149
ITEM 11. EXECUTIVE COMPENSATION
The information required by this item will be contained in the Proxy Statement and is incorporated in this Annual Report on Form 10-K by reference.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS
The information required by this item will be contained in the Proxy Statement and is incorporated in this Annual Report on Form 10-K by reference.
150
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED PARTY TRANSACTIONS
The information required by this item will be contained in the Proxy Statement and is incorporated in this Annual Report on Form 10-K by reference.
151
ITEM 14. PRINCIPAL ACCOUNTING FEES AND SERVICES
The information required by this item will be contained in the Proxy Statement and is incorporated in this Annual Report on Form 10-K by reference.
152
PART IV
ITEM 15. EXHIBITS, FINANCIAL STATEMENT SCHEDULES
(a) The following documents are filed as part of this Annual Report on Form 10-K:
(1) FINANCIAL STATEMENTS
Our consolidated financial statements are listed in the “Index to the Financial Statements” under Part II, Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
(2) FINANCIAL STATEMENT SCHEDULES
All schedules to the financial statements are omitted because they are not applicable, not material or the required information is shown in Par II, Item 8, “Financial Statements and Supplementary Data” of this Annual Report on Form 10-K.
(3) EXHIBITS
The documents listed in the Exhibit Index of this Annual Report on Form 10-K are incorporated by reference or are filed with this Annual Report on Form 10-K, in each case as indicated therein.
EXHIBIT INDEX
| Exhibit Number | Description of Document | Form | File No. | Exhibit | Filing Date | Filed Herewith | ||||||||||||||||||||||||||||||||
| 3.1 | 8-K | 001-39562 | 3.1 | October 5, 2020 | ||||||||||||||||||||||||||||||||||
| 3.2 | S-1/A | 333-248635 | 3.4 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 4.1 | S-1/A | 333-248635 | 4.1 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 4.2 | S-1/A | 333-248635 | 4.2 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 4.3 | X | |||||||||||||||||||||||||||||||||||||
| 10.1+ | S-8 | 333-249187 | 99.1 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
| 10.2+ | S-8 | 333-249187 | 99.2 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
| 10.3+ | S-8 | 333-249187 | 99.3 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
| 10.4+ | S-8 | 333-249187 | 99.4 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
| 10.5+ | S-8 | 333-249187 | 99.5 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
153
| 10.6+ | S-8 | 333-249187 | 99.6 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
| 10.7+ | S-8 | 333-249187 | 99.7 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
| 10.8+ | S-8 | 333-249187 | 99.8 | October 1, 2020 | ||||||||||||||||||||||||||||||||||
| 10.9 | S-1/A | 333-248635 | 10.9 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.10+ | S-1/A | 333-248635 | 10.10 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.11+ | S-1/A | 333-248635 | 10.11 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.12+ | S-1/A | 333-248635 | 10.12 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.13+ | X | |||||||||||||||||||||||||||||||||||||
| 10.14+ | S-1/A | 333-248635 | 10.13 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.15+ | S-1/A | 333-248635 | 10.14 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.16+ | S-1/A | 333-248635 | 10.15 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.17+ | S-1/A | 333-248635 | 10.16 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.18+ | S-1/A | 333-248635 | 10.17 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.19 | S-1/A | 333-248635 | 10.18 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.20 | S-1/A | 333-248635 | 10.19 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
154
| 10.21 | S-1/A | 333-248635 | 10.20 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.22 | S-1/A | 333-248635 | 10.21 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.23 | S-1/A | 333-248635 | 10.22 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.24 | S-1/A | 333-248635 | 10.23 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.25 | S-1/A | 333-248635 | 10.24 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.26 | S-1/A | 333-248635 | 10.25 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.27 | S-1/A | 333-248635 | 10.26 | September 24, 2020 | ||||||||||||||||||||||||||||||||||
| 10.28 | S-1/A | 333-248635 | 10.27 | September 28, 2020 | ||||||||||||||||||||||||||||||||||
| 10.29+ | S-1/A | 333-248635 | 10.28 | September 28, 2020 | ||||||||||||||||||||||||||||||||||
| 21.1 | X | |||||||||||||||||||||||||||||||||||||
| 23.1 | X | |||||||||||||||||||||||||||||||||||||
| 24.1 | X | |||||||||||||||||||||||||||||||||||||
| 31.1 | X | |||||||||||||||||||||||||||||||||||||
| 31.2 | X | |||||||||||||||||||||||||||||||||||||
| 32.1* | ||||||||||||||||||||||||||||||||||||||
155
___________________
+ Indicates management contract or compensatory plan
* The certifications attached as Exhibits 32.1 and 32.2 accompanying this Annual Report on Form 10-K are not deemed filed with the SEC and are not to be incorporated by reference into any filing of the Company under the Securities Act or the Exchange Act whether made before or after the date of this Annual Report on Form 10-K, irrespective of any general incorporation language contained in such filing.
Item 16. Form 10-K Summary.
None.
156
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, the registrant has duly caused this registration statement to be signed on its behalf by the undersigned, thereunto duly authorized, in Redwood City, State of California, on the 15th day of March, 2021.
| PULMONX CORPORATION | ||||||||
| By: | /s/Glendon E. French | |||||||
| Glendon E. French | ||||||||
| President, Chief Executive Officer and Director | ||||||||
| By: | /s/Derrick Sung | |||||||
| Derrick Sung, Ph.D. | ||||||||
| Chief Financial Officer | ||||||||
POWER OF ATTORNEY
KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Glendon E. French and Derrick Sung, jointly and severally, as his true and lawful attorneys-in-fact and agents, with full power of substitution and resubstitution, for him and in his name, place, and stead, in any and all capacities, to sign any and all amendments to this Annual Report on Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the Securities and Exchange Commission, granting unto said attorneys-in-fact and agents full power and authority to do and perform each and every act and thing requisite and necessary to be done in and about the premises, as fully to all intents and purposes as he might or could do in person, hereby ratifying and confirming that all said attorneys-in-fact and agents, or his or their substitute or substitutes, may lawfully do or cause to be done by virtue hereof.
Pursuant to the requirements of the Securities Exchange Act of 1934, this Annual Report on Form 10-K has been signed below by the following persons on behalf of the Registrant and in the capacities and on the dates indicated:
| Signature | Title | Date | ||||||
| /s/Glendon E. French | President, Chief Executive Officer and Director | March 15, 2021 | ||||||
| Glendon E. French | (Principal Executive Officer) | |||||||
| /s/Derrick Sung, Ph.D. | Chief Financial Officer | March 15, 2021 | ||||||
| Derrick Sung, Ph.D. | (Principal Financial Officer and Principal Accounting Officer) | |||||||
| /s/Thomas W. Burns | Director | March 15, 2021 | ||||||
| Thomas W. Burns | ||||||||
| /s/Richard Ferrari | Director | March 15, 2021 | ||||||
| Richard Ferrari | ||||||||
| /s/Daniel P. Florin | Director | March 15, 2021 | ||||||
| Daniel P. Florin | ||||||||
| /s/Georgia Garinois-Melenikiotou | Director | March 15, 2021 | ||||||
| Georgia Garinois-Melenikiotou | ||||||||
| /s/Staffan Lindstrand | Director | March 15, 2021 | ||||||
| Staffan Lindstrand | ||||||||
| /s/Dana G. Mead, Jr. | Director | March 15, 2021 | ||||||
| Dana G. Mead, Jr. | ||||||||
157