You should read the following discussion and analysis of our financial condition and results of operations together with our condensed consolidated financial statements and the related notes and other financial information included elsewhere in this Quarterly Report on Form 10-Q. This discussion and other parts of this report contain forward-looking statements that involve risks and uncertainties, such as statements of our plans, objectives, expectations and intentions, that are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those discussed in the section of this report entitled "Risk Factors," under Part II, Item 1A and those discussed in our Annual Report on Form 10-K filed with theSecurities and Exchange Commission ("SEC") onMarch 15, 2021 . Please also see the section of this Quarterly Report on Form 10-Q titled "Forward-Looking Statements." 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 inthe 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 inThe New England Journal of Medicine ,The Lancet and theAmerican 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. InJune 2018 , we received pre-market approval ("PMA") by theU.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 100,000 valves used to treat more than 25,000 patients. We have established reimbursement in major markets inNorth America ,Europe andAsia Pacific and the Zephyr Valve has been included in treatment guidelines for COPD worldwide. We market and sell our products inthe 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 inthe United States . We are expanding our commercial operations inthe 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. Inthe 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 inthe United States is believed to cover the hospital costs of the procedure and related inpatient care. Commercial payors such as Aetna,Anthem Blue Cross Blue Shield ,Blue Cross Blue Shield of Michigan , Humana,Health Care Service Corporation , and Highmark have issued positive coverage policies for the Zephyr Valve, andUnited 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. Outsidethe United States , our solution is covered by major health systems across much ofEurope ,Australia andSouth Korea . 31 -------------------------------------------------------------------------------- We manufacture all our products at our headquarters located inRedwood 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 bothU.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$13.3 million , with a gross margin of 73.4% and a net loss of$10.2 million , for the three months endedSeptember 30, 2021 compared to revenue of$10.6 million , with a gross margin of 70.3% and a net loss of$3.9 million , for the three months endedSeptember 30, 2020 . For the nine months endedSeptember 30, 2021 , we generated revenue of$34.7 million , with a gross margin of 73.1% and a net loss of$35.7 million , compared to revenue of$22.9 million , with a gross margin of 61.7% and a net loss of$22.9 million , for the nine months endedSeptember 30, 2020 . As ofSeptember 30, 2021 , we had an accumulated deficit of$278.4 million , cash, cash equivalents and marketable securities of$202.6 million , and$17.4 million of outstanding term loans and credit agreements, net of debt discount and debt issuance costs. 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 throughoutthe United States ,Europe andAsia 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, cash equivalents and marketable securities will allow the Company to continue its operations for at least the next 12 months from the date of the issuance of our condensed consolidated financial statements. Impact of the COVID-19 Pandemic The COVID-19 pandemic has resulted in public health responses including travel bans, social distancing requirements, quarantines, stay-at-home orders and other significant measures, which have delayed clinical trials and FDA operations and adversely impacted the number of procedures performed using our products. 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. As a result, we have experienced a material adverse impact on our business, financial condition and results of operations from a decrease and delay of procedures involving our products. Beginning inMay 2020 , we began to see signs of a recovery in our business, and bySeptember 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 andDecember 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 into the first quarter of 2021. Beginning inMarch 2021 , we observed indicators of recovery in our US markets which continued through the second quarter. During the third quarter of 2021, procedure volumes were again adversely impacted in theU.S. in certain regions that were affected by the Delta variant of COVID-19. In international markets, our business recovered during the third quarter of 2021, due to procedure volumes increasing as COVID-19 cases gradually declined through the quarter. We may 32 -------------------------------------------------------------------------------- continue to see regional variations in procedure volumes in our US markets from the COVID-19 pandemic and its variants. 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; •a strong patient pipeline evidenced by an increase in StratX report activity, 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 accepting patients for elective procedures. In response to the COVID-19 pandemic, we 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 ourU.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 our IPO inOctober 2020 ; and •continuing to invest in research and development activities in order to advance our AeriSeal clinical programs. Despite signs of recovery of our business, we cannot be certain that any recovery will be sustained, or that a further resurgence of COVID-19 or variants of the virus will not occur. 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 continues to present 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 theU.S. and world economy and in financial markets. We cannot assure you that our recent volume of Zephyr Valves sold are indicative of future results. The number of Zephyr Valves sold in the future may decrease due to a resurgence of the COVID-19 pandemic. Further, there may be limited provider capacity due to labor shortages, or for other reasons, which could limit the ability of patients to receive treatment with Zephyr Valves. We believe limited provider and hospital capacity could continue to have a material adverse effect on our business, financial condition and results of operations as the pandemic subsides and following the end of the pandemic. Our business, financial condition and results of operations have been, and may in the future be, materially and adversely affected by the COVID-19 pandemic. The extent to which the COVID-19 pandemic impacts our business, financial condition and results of operations will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the 33 -------------------------------------------------------------------------------- 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 condensed 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 II, 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. 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 inthe United States inJune 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,Anthem Blue Cross Blue Shield (BCBS),Blue Cross Blue Shield of Michigan , Humana,Health Care Service Corporation , and Highmark have issued positive coverage policies for the Zephyr Valve, andUnited Healthcare no longer considers the procedure unproven or experimental. Some commercial payors do not yet consider our solution medically necessary, but these 34 -------------------------------------------------------------------------------- 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 inthe 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 inthe 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. Outsidethe United States , our solution is covered by major health systems across much ofEurope ,Australia andSouth 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. 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 are conducting 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 ofthe United States , primarily in the first and third quarters and anticipate this trend to continue. In addition, as our sales grow inthe United States , we may experience seasonality based on holidays, vacations and other factors because this is an elective procedure. 35 -------------------------------------------------------------------------------- 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 inthe United States and through direct sales and several third-party distributors in select markets outsidethe 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 three and nine months endedSeptember 30, 2021 andSeptember 30, 2020 . 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 ofU.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 theU.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 management and an allocation of 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 inthe 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 36 -------------------------------------------------------------------------------- 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 our sales and marketing spending to generate sales opportunities. We expect expenses to increase in absolute dollars as we 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 and tax-related services associated with being a public company, compliance with exchange listing andSEC 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, including amortization of debt discount and issuance costs. Interest income is predominantly derived from investing surplus cash in money market funds and 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 preferred stock warrants and foreign currency exchange gains and losses. InFebruary 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 IPO onOctober 5, 2020 , we paid$1.9 million pursuant to the Success Fee Agreement toOxford Finance LLC . In connection with the closing of our IPO, the 2020 Notes were converted into 2,561,484 shares of common stock. 37 -------------------------------------------------------------------------------- Results of Operations: Comparison of the Three Months EndedSeptember 30, 2021 and 2020 The following table summarizes our results of operations for the period indicated: Three Months Ended September 30, 2021 2020 $ Change % Change (in thousands) Revenue$ 13,261 $ 10,612 $ 2,649 25.0 % Costs of goods sold 3,522 3,150 372 11.8 % Gross profit 9,739 7,462 2,277 30.5 % Operating expenses: Research and development 2,815 1,997 818 41.0 % Selling, general and administrative 16,686 10,813 5,873 54.3 % Total operating expenses 19,501 12,810 6,691 52.2 % Loss from operations (9,762) (5,348) (4,414) 82.5 % Interest income 99 9 90 1,000.0 % Interest expense (207) (1,103) 896 (81.2) % Other income (expense), net (267) 2,631 (2,898) (110.1) % Net loss before tax (10,137) (3,811) (6,326) 166.0 % Income tax expense 44 49 (5) (10.2) % Net loss$ (10,181) $ (3,860) $ (6,321) 163.8 % Revenue Revenue increased by$2.6 million , or 25.0%, to$13.3 million during the three months endedSeptember 30, 2021 , compared to$10.6 million during the three months endedSeptember 30, 2020 . The sale of products inthe United States increased by$1.6 million to$6.9 million during the three months endedSeptember 30, 2021 , compared to$5.3 million for the three months endedSeptember 30, 2020 . The sale of products in international markets increased by$1.1 million to$6.4 million during the three months endedSeptember 30, 2021 , compared to$5.3 million for the three months endedSeptember 30, 2020 . The increase in revenue across regions was driven by an increase in procedure volumes from increasing commercial adoption in select markets that were less affected by COVID-19. Cost of Goods Sold and Gross Margin Cost of goods sold increased by$0.4 million , or 11.8%, to$3.5 million during the three months endedSeptember 30, 2021 , compared to$3.2 million during the three months endedSeptember 30, 2020 . The increase was primarily due to growth in shipments. Gross margin was 73.4% during the three months endedSeptember 30, 2021 and 70.3% during the three months endedSeptember 30, 2020 . Research and Development Expenses Research and development expenses increased by$0.8 million , or 41.0%, to$2.8 million during the three months endedSeptember 30, 2021 , compared to$2.0 million during the three months endedSeptember 30, 2020 . The increase in research and development expense was primarily due to increases of$0.4 million of costs associated with our clinical trials,$0.2 million in research and development testing and consulting expenses, and$0.2 million in facilities, personnel related, and other expenses. 38 -------------------------------------------------------------------------------- Selling, General and Administrative Expenses Selling, general and administrative expenses increased by$5.9 million , or 54.3%, to$16.7 million during the three months endedSeptember 30, 2021 , compared to$10.8 million during the three months endedSeptember 30, 2020 . The increase in selling, general and administrative expenses was primarily due to$3.5 million of payroll and personnel-related expenses including stock based compensation for our sales, marketing and administrative personnel, an increase of$1.1 million in advertising expenses, an increase of$0.7 million in insurance costs associated with being a public company, and an increase of$0.6 million in consulting, recruiting, and facilities expense. Interest Expense and Income Interest expense decreased by$0.9 million to$0.2 million during the three months endedSeptember 30, 2021 , compared to$1.1 million during the three months endedSeptember 30, 2020 primarily due to a lower amount of debt outstanding during the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 . Interest income increased by$0.1 million for the three months endedSeptember 30, 2021 compared to the three months endedSeptember 30, 2020 , primarily as a result of higher balances of our cash, cash equivalents and marketable securities balances. Other Income (Expense), Net Other income (expense), net decreased by$2.9 million to$(0.3) million during the three months endedSeptember 30, 2021 , compared to$2.6 million during the three months endedSeptember 30, 2020 , primarily due to a change in the fair value of derivative liabilities in 2020. Comparison of the Nine Months EndedSeptember 30, 2021 and 2020 The following table summarizes our results of operations for the period indicated: Nine Months Ended September 30, 2021 2020 $ Change % Change (in thousands) Revenue $ 34,708$ 22,903 $ 11,805 51.5 % Costs of goods sold 9,329 8,779 550 6.3 % Gross profit 25,379 14,124 11,255 79.7 % Operating expenses: Research and development 9,355 4,988 4,367 87.6 % Selling, general and administrative 50,962 32,114 18,848 58.7 % Total operating expenses 60,317 37,102 23,215 62.6 % Loss from operations (34,938) (22,978) (11,960) 52.0 % Interest income 306 98 208 212.2 % Interest expense (630) (2,914) 2,284 (78.4) % Other income (expense), net (202) 3,052 (3,254) (106.6) % Net loss before tax (35,464) (22,742) (12,722) 55.9 % Income tax expense 191 192 (1) (0.5) % Net loss$ (35,655) $ (22,934) $ (12,721) 55.5 % 39
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Revenue
Revenue increased by$11.8 million , or 51.5%, to$34.7 million during the nine months endedSeptember 30, 2021 , compared to$22.9 million during the nine months endedSeptember 30, 2020 . The sale of products inthe United States increased by$6.4 million to$17.7 million during the nine months endedSeptember 30, 2021 , compared to$11.3 million for the nine months endedSeptember 30, 2020 . The sale of products in international markets increased by$5.4 million to$17.0 million during the nine months endedSeptember 30, 2021 , compared to$11.6 million for the nine months endedSeptember 30, 2020 . The increase in revenue across regions was driven by an increase in procedure volumes due to a relative recovery from the COVID-19 pandemic and increasing commercial adoption in select markets. Cost of Goods Sold and Gross Margin Cost of goods sold increased by$0.6 million , or 6.3%, to$9.3 million during the nine months endedSeptember 30, 2021 , compared to$8.8 million during the nine months endedSeptember 30, 2020 . The increase was primarily due to growth in shipments. Gross margin was 73.1% during the nine months endedSeptember 30, 2021 and 61.7% during the nine months endedSeptember 30, 2020 . Research and Development Expenses Research and development expenses increased by$4.4 million , or 87.6%, to$9.4 million during the nine months endedSeptember 30, 2021 , compared to$5.0 million during the nine months endedSeptember 30, 2020 . The increase in research and development expense was primarily due to increases of$1.9 million of costs associated with our clinical trials,$1.5 million in personnel related expenses including stock based compensation as we invested in research and development activities,$0.6 million of research and development testing and consulting expenses, and$0.4 million of expenses in facilities. Selling, General and Administrative Expenses Selling, general and administrative expenses increased by$18.8 million , or 58.7%, to$51.0 million during the nine months endedSeptember 30, 2021 , compared to$32.1 million during the nine months endedSeptember 30, 2020 . The increase in selling, general and administrative expenses was primarily due to increase of$13.6 million in payroll and personnel-related expenses including stock based compensation for our sales, marketing and administrative personnel,$2.8 million in advertising expenses,$2.1 million in insurance costs associated with being a public company,$2.1 million in consulting and recruiting expenses,$0.5 million in facilities expense, and an increase of$0.7 million in other expenses, offset by a decrease of$3 million in IPO expenses written-off in the prior year. Interest Expense and Income Interest expense decreased by$2.3 million to$0.6 million during the nine months endedSeptember 30, 2021 , compared to$2.9 million during the nine months endedSeptember 30, 2020 primarily due to the conversion of convertible notes in 2020. Interest income increased by$0.2 million for the nine months endedSeptember 30, 2021 compared to the nine months endedSeptember 30, 2020 , primarily as a result of higher balances of our cash, cash equivalents and marketable securities balances. Other Income (Expense), Net Other income (expense), net decreased by$3.3 million to$(0.2) million during the nine months endedSeptember 30, 2021 , compared to$3.1 million during the nine months endedSeptember 30, 2020 , primarily due to a change in the fair value of derivative liabilities in 2020. 40 -------------------------------------------------------------------------------- Liquidity and Capital Resources; Plan of Operation To date, we have financed our operations primarily through the sale of equity securities, debt financing arrangements and sales of our products. As ofSeptember 30, 2021 , we had cash, cash equivalents and marketable securities of$202.6 million , an accumulated deficit of$278.4 million , and$16.9 million outstanding under the CIBC Term Loan, net of debt discount. Oxford Term Loan FromAugust 2014 untilFebruary 2020 , we were party to a Loan and Security Agreement with Oxford (the "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. In connection with the closing of the Oxford Agreement inAugust 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 beforeAugust 28, 2021 . We borrowed a total of$15.0 million principal amount of term loans 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 inOctober 2020 . InFebruary 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. OnOctober 5, 2020 , upon the closing of our IPO, we paid$1.9 million pursuant to the Success Fee Agreement toOxford Finance LLC . In the three and nine months endedSeptember 30, 2020 , we recorded interest expense on the term loan of$0 million and$0.4 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 the three and nine months endedSeptember 30, 2020 , we recorded interest expense related to deferred financing and debt issuance costs of$0 million and less than$0.1 million , respectively. CIBC Term Loan OnFebruary 20, 2020 , we executed a Loan and Security Agreement with Canadian Imperial Bank of Commerce ("CIBC"), which we subsequently amended onApril 17, 2020 ,December 28, 2020 andMarch 29, 2021 (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 beforeFebruary 20, 2022 and an additional$7.0 million ("Tranche C") on or beforeFebruary 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 bears interest at a floating rate equal to 1.0% above theWall 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 41 -------------------------------------------------------------------------------- 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. InDecember 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 toJune 30, 2021 . InMarch 2021 , we entered into a Third Amendment to the CIBC Agreement which extended the loan maturity date fromMarch 15, 2022 toFebruary 20, 2025 , and modified certain financial covenants. Per the amended terms, 36 equal payments of principal plus accrued interest will be due beginningMarch 31, 2022 . The beginning of principal repayment can be extended toMarch 31, 2023 if the Company achieves three-month trailing revenue of at least$20.0 million as ofFebruary 20, 2022 . The amendment was accounted for as a debt modification and no gain or loss was recognized. InJune 2021 , the Company entered into an amended and restated loan and security agreement with CIBC that extended the compliance date for certain post-close covenants toMarch 31, 2022 . We paid$0.4 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 each three months endedSeptember 30, 2021 and 2020, we recorded interest expense related to debt discount and debt issuance costs of CIBC Loan of less than$0.1 million . During the nine months endedSeptember 30, 2021 and 2020, we recorded interest expense related to debt discount and debt issuance costs of CIBC Loan of$0.1 million and$0.1 million , respectively. Interest expense on the CIBC Loan was$0.2 million and$0.2 million during the three months endedSeptember 30, 2021 and 2020, respectively. Interest expense on the CIBC Loan was$0.6 million and$0.5 million during the nine months endedSeptember 30, 2021 and 2020, respectively. 2020 Notes InApril 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 toApril 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 ofApril 17, 2022 or an event of default. The Company may prepay the 2020 Notes prior toApril 17, 2022 only with the consent of the Majority Holders. The 2020 Notes included embedded derivatives that were 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 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. The fair value of the 2020 derivative liability upon the effectiveness of our 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. 42 -------------------------------------------------------------------------------- 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 inOctober 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 InApril 2020 , Pulmonx International Sàrl, our wholly-owned subsidiary, entered into a COVID-19 Credit Agreement withUBS Switzerland AG to receive up to0.5 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. InMay 2020 , Pulmonx International Sàrl received0.5 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 ofSeptember 30, 2021 ,Pulmonx International Sàrl did not make any repayment of the credit agreement. 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 ofSeptember 30, 2021 , we had cash, cash equivalents and marketable securities of$202.6 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 condensed consolidated financial statements as of and for the three months endedSeptember 30, 2021 . 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 inthe 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 inthe United States and elsewhere; •changes or fluctuations in our inventory supply needs and forecasts of our supply needs; 43
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•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 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:
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