Item 7. Management’s Discussion and Analysis
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes to those statements included elsewhere in this Annual Report on Form 10-K. In addition to historical financial information, the following discussion and analysis contains forward-looking statements that involve risks, uncertainties, and assumptions. Some of the numbers included herein have been rounded for the convenience of presentation. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of many factors, including those discussed under Part I. "Item 1A. Risk Factors’’ and elsewhere in this Annual Report on Form 10-K.
Overview
We are a medical technology company focused on the development and commercialization of innovative and minimally invasive solutions for patients with OSA. Our proprietary Inspire system is the first and only FDA-approved neurostimulation technology that provides a safe and effective treatment for moderate to severe OSA. We have developed a novel, closed-loop solution that continuously monitors a patient’s breathing and delivers mild hypoglossal nerve stimulation to maintain an open airway. Inspire therapy is indicated for patients with moderate to severe OSA who do not have significant central sleep apnea and do not have a complete concentric collapse of the airway at the soft palate level. In addition, patients in the U.S. must have been confirmed to fail or be unable to tolerate positive airway pressure treatments, such as CPAP, and be 18 years of age or older, though there are no similar requirements for patients in Europe.
We sell our Inspire system to hospitals and ASCs in the U.S. and in select countries in Europe through a direct sales organization. Our direct sales force engages in sales efforts and promotional activities focused on ENT physicians and sleep centers. In addition, we highlight our compelling clinical data and value proposition to increase awareness and adoption amongst referring physicians. We build upon this top-down approach with strong direct-to-consumer marketing initiatives to create awareness of the benefits of our Inspire system and drive interest through patient empowerment. This outreach helps to educate thousands of patients on our Inspire therapy. We increased the number of employees in our sales, marketing, and reimbursement organizations from 40 as of December 31, 2015 to 252 as of December 31, 2020.
Although our sales and marketing efforts are directed at patients and physicians because they are the primary users of our technology, we consider the hospitals and ASCs where the procedure is performed to be our customers, as they are the purchasing agents of our Inspire system. Our customers are reimbursed the cost required to treat each patient through various third-party payors, such as commercial payors and government agencies. Our Inspire system is currently reimbursed primarily on a per-patient prior authorization basis for patients covered by commercial payors, under Local Coverage Determinations for patients covered by Medicare, and under U.S. government contract for patients who are treated by the Veterans Health Administration. As of February 23, 2021, we have secured positive coverage policies with 63 U.S. commercial payors, covering approximately 220 million lives in the U.S. In addition, all seven Medicare Administrative Contractors ("MACs") published final policies in 2020 that provide coverage of Inspire therapy when certain coverage criteria are met.
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The procedure performed to implant our device is currently described for billing purposes using a Category I Current Procedural Terminology (“CPT”) code (64568), which is used in conjunction with a temporary Category III CPT code (0466T). At the October 2020 AMA CPT Editorial Panel meeting, the AMA approved the creation of new Category I CPT codes to separately identify hypoglossal nerve stimulator services. A Category I code was also approved for Drug-Induced Sleep Endoscopy, which is the final procedure to determine which patients are appropriate for Inspire therapy. These new codes are scheduled to go into effect beginning January 1, 2022. With these approvals, a formal survey will be conducted to determine the Medicare reimbursement levels assigned to each code. The results of this survey are expected to be announced in July 2021 and reviewed by the Centers for Medicare and Medicaid Services (“CMS”) in conjunction with the annual Medicare Physician Fee Schedule rulemaking cycle. In June 2018, Japan’s Ministry of Health, Labour and Welfare approved our Inspire therapy to treat moderate to severe OSA, and we are currently seeking reimbursement in Japan. In August 2020, the Australian Therapeutic Goods Administration approved Inspire therapy to treat moderate to severe OSA, and we are currently seeking reimbursement in Australia. For the year ended December 31, 2020, 92.0% of our revenue was derived in the U.S. and 8.0% was derived in Europe. No single customer accounted for more than 10% of our revenue.
Our marketing efforts during the first half of 2020 included refocused direct-to-consumer marketing strategies, which initially included a shift from radio and TV in our larger markets that were affected by COVID-19 towards more digital and TV in smaller markets. During the second quarter of 2020, and continuing in the third quarter of 2020, we resumed radio and TV initiatives in our larger markets as the impact of COVID-19 lessened in those areas. We continue to monitor the impacts of COVID-19 in each advertising market and may again change our advertising strategy on a market-by-market basis if needed. Further, our team has leveraged virtual tools, such as the new Inspire Sleep app released during the second quarter of 2020, to continue physician training and patient education.
We rely on third-party suppliers to manufacture our Inspire system and its components. Many of these suppliers are currently single source suppliers. We seek to maintain higher levels of inventory to protect ourselves from supply interruptions, and, as a result, we are subject to the risk of inventory obsolescence and expiration, which could lead to inventory impairment charges. In the U.S., our products are shipped directly to our customers on a purchase order basis, primarily by a third-party vendor with a facility in Tennessee, although we do ship some products from our facility in Minnesota. Warehousing and shipping operations for our European customers are handled by a third-party vendor with a facility located in the Netherlands. Customers do not have the right to return non-defective product, nor do we place product on consignment. Our sales representatives do not maintain trunk stock.
Since our inception in 2007, we have financed our operations primarily through sales of our Inspire system, private placements of our convertible preferred securities, amounts borrowed under our credit facility and equity offerings of our common stock. In April 2020, we sold 2,300,000 shares of common stock at a public offering price of $58.00 per share and received net proceeds of approximately $124.7 million after deducting underwriting discounts, commissions, and offering expenses. We have devoted significant resources to research and development activities related to our Inspire system, including clinical and regulatory initiatives to obtain marketing approval, and sales and marketing activities. For the year ended December 31, 2020, we generated revenue of $115.4 million with a gross margin of 84.7% and a net loss of $57.2 million, compared to revenue of $82.1 million with a gross margin of 83.4% and a net loss of $33.2 million for the year ended December 31, 2019, and revenue of $50.6 million with a gross margin of 80.1% and a net loss of $21.8 million for the year ended December 31, 2018. Our accumulated deficit as of December 31, 2020 was $237.3 million.
We have invested heavily in product development. Our research and development activities have been centered on driving continuous improvements to our Inspire therapy. We have also made significant investments in clinical studies to demonstrate the safety and efficacy of our Inspire therapy and to support regulatory submissions. We also continue to make significant investments building our sales and marketing organization by increasing the number of U.S. sales representatives and continuing our direct-to-consumer marketing efforts in existing and new markets throughout the U.S. and in Europe. During 2020, we activated 141 centers bringing the total to 425 U.S. medical centers implanting Inspire therapy as of December 31, 2020. Driven by the more favorable reimbursement environment, we have increased our focus on adding ASCs. At the end of 2020, ASCs made up just over 15% of our total U.S. implanting centers, up from nearly 10% at the end of 2019. Additionally, we created
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34 new territories during 2020, bringing the total to 107 U.S. territories as of December 31, 2020. We continue to make investments in research and development efforts to develop our next generation Inspire systems and support our future regulatory submissions for expanded indications and for new markets such as Europe, Japan, and Australia. For example, in April 2020, we received FDA approval for an expanded age-range for Inspire therapy to include 18 to 21 year old patients, and in August 2020, the Australian Therapeutic Goods Administration approved Inspire therapy to treat moderate to severe OSA. Because of these and other factors, we expect to continue to incur net losses for the next several years, and we expect to require substantial additional funding, which may include future equity and debt financings.
Outlook
We expect the COVID-19 pandemic to continue to adversely impact our revenue due to decreases and delays in the number of Inspire therapy procedures performed and patients screened for eligibility for Inspire therapy. Beginning in the second week of March 2020, substantially all of the scheduled Inspire therapy procedures were postponed and numerous other authorized cases were unable to be scheduled. During April 2020, the widespread shutdown in elective surgical procedures continued. Beginning in May 2020, surgical volumes began increasing steadily, with most implanting centers performing procedures by October 2020. A portion of the remaining 2020 procedures performed were those rescheduled from the first half of 2020, and, as a result of which, the initial backlog of postponed cases has largely been eliminated. The resurgence of COVID-19 in various U.S. regions has, and will likely continue to, adversely impact our procedure volumes.
In response to the spread of COVID-19 and in line with recommendations from federal and local government and healthcare agencies, we transitioned employees, except for those deemed essential to key aspects of our business, to a remote work environment. Beginning in May 2020, our corporate office re-opened with strict sanitation and physical distancing protocols, although many corporate employees continue to work remotely as a heightened precautionary measure. Additionally, our field staff continues to primarily work remotely and must adhere to applicable COVID-19 protocols when visiting hospitals and ASCs. During the period which surgical procedures were significantly limited, we identified and implemented innovative solutions to support patients who have Inspire therapy, as well as continued to educate patients who may be struggling with their sleep apnea. Patients continue to reach out to learn more about the therapy and get connected to a healthcare provider, and we are supporting this interaction through the use of several virtual tools, including the new Inspire Sleep app, and other online tools. We are also continuing with our planned expansion in recruiting Territory Managers and sales support roles.
To date, we have not experienced disruptions to our supply chain network as a result of the COVID-19 pandemic. We have also not reduced our capital expenditures and are continuing to invest in research and development, however, we may determine to allocate resources differently due to impacts of the COVID-19 pandemic.
We believe that our existing cash resources will be sufficient to meet our capital requirements and fund our operations for at least the next 12 months. For additional information, see “Liquidity and Capital Resources.”
Components of Our Results of Operations
Revenue
We derive primarily all of our revenue from the sale of our Inspire system to hospitals and ASCs in the U.S. and select countries in Europe. We recognize revenues from sales of our Inspire system when the customer obtains control of the product, which occurs at a point in time, either upon shipment of the product or receipt of the product, depending on shipment terms.
Our revenue has fluctuated, and may continue to fluctuate, from quarter to quarter due to a variety of factors. For example, we have historically experienced seasonality in our first and fourth quarters and have experienced adverse impacts on our revenue due to the COVID-19 pandemic.
Revenue for the year ended December 31, 2020 was negatively impacted due to the global pandemic associated with COVID-19. Specifically, in March 2020, healthcare facilities and clinics began restricting access to their
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clinicians, reducing patient consultations and treatments or temporarily closing their facilities. As a result, beginning in the second week of March 2020, substantially all of our then-scheduled Inspire therapy procedures were postponed, and numerous other cases with prior authorization could not be scheduled and were, therefore, also postponed. During April 2020, the widespread shutdown in elective surgical procedures continued, but surgical volumes began increasing in May and even further in June, though still remaining below pre-COVID-19 levels. By the end of the third quarter of 2020, most implanting centers had resumed procedures. A portion of the second, third and fourth quarter 2020 procedures performed were rescheduled from the first half of 2020, and, as a result of which, the backlog of postponed cases has largely been eliminated.
Cost of Goods Sold and Gross Margin
Cost of goods sold consists primarily of acquisition costs for the components of the Inspire system, overhead costs, scrap, and inventory obsolescence, warranty replacement costs, as well as distribution-related expenses such as logistics and shipping costs, net of shipping costs charged to customers. The overhead costs include the cost of material procurement, depreciation expense for production equipment, and operations supervision and management personnel, including employee compensation, stock-based compensation, supplies, and travel. We expect cost of goods sold to increase or decrease in absolute dollars primarily as, and to the extent, our revenue grows or declines, respectively.
We calculate gross margin as gross profit divided by revenue. Our gross margin has been and we expect it will continue to be affected by a variety of factors, including manufacturing costs, the average selling price of our Inspire system, the implementation of cost-reduction strategies, inventory obsolescence costs, which generally occur when new generations of our Inspire system are introduced, and to a lesser extent the sales mix between the U.S. and Europe as our average selling price in the U.S. tends to be higher than in Europe. Our gross margin may increase over the long term to the extent our production volumes increase and we receive discounts on the costs charged by our contract manufacturers, thereby reducing our per unit costs. However, our gross margin may fluctuate from quarter to quarter due to seasonality.
Research and Development Expenses
Research and development expenses consist primarily of product development, engineering, clinical studies to develop and support our products, regulatory expenses, quality assurance, testing, consulting services and other costs associated with the next generation versions of the Inspire system. These expenses include employee compensation, including stock-based compensation, supplies, materials, consulting, and travel expenses related to research and development programs. Additionally, these expenses include clinical trial management, payments to clinical investigators, data management and travel expenses for our various clinical trials. We expect research and development expenses to increase in the future as we develop next generation versions of our Inspire system and continue to expand our clinical studies to secure positive coverage policies from private commercial payors in the U.S. and enter into new markets including additional European countries, Japan, and Australia. We expect research and development expenses as a percentage of revenue to vary over time depending on the level and timing of initiating new product development efforts and new clinical development activities.
Selling, General and Administrative Expenses
Selling, general and administrative expenses consist primarily of compensation for personnel, including base salaries, stock-based compensation expense and commissions related to our sales organization, finance, information technology, and human resource functions, as well as spending related to marketing, sales operations, and training and reimbursement personnel. Other selling, general and administrative expenses include training physicians, travel expenses, advertising, direct-to-consumer promotional programs, conferences, trade shows and consulting services, professional services fees, audit fees, insurance costs and general corporate expenses, including facilities-related expenses.
We expect selling, general and administrative expenses to continue to increase as we expand our commercial infrastructure to both drive and support our planned growth in revenue and as we increase our headcount and expand administrative personnel to support our growth and operations as a public company including finance personnel and information technology services. Additionally, we anticipate an increase in our stock-based
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compensation expense with grants of restricted stock or options and shares of our common stock purchased pursuant to our employee stock purchase plan.
Other Expense (Income), Net
Other expense (income), net consists primarily of interest expense payable under our credit facility and interest income. Other items have included fair value adjustments related to convertible preferred stock warrants, which were accounted for as a liability and marked-to-market at each reporting period. Immediately prior to the closing of our IPO, our outstanding convertible preferred stock warrants automatically converted into warrants to purchase shares of our common stock.
Results of Operations
Year Ended December 31, 2020 Compared to Year Ended December 31, 2019
Year Ended December 31, Change
2020 2019 $ %
(in thousands, except percentages)
Revenue $ 115,381 $ 82,050 $ 33,331 40.6 %
Cost of goods sold 17,623 13,643 3,980 29.2 %
Gross profit 97,758 68,407 29,351 42.9 %
Gross margin 84.7 % 83.4 %
Operating expenses:
Research and development 26,092 12,839 13,253 103.2 %
Selling, general and administrative 127,874 90,465 37,409 41.4 %
Total operating expenses 153,966 103,304 50,662 49.0 %
Operating loss (56,208) (34,897) (21,311) 61.1 %
Other expense (income), net 880 (1,694) 2,574 (151.9) %
Loss before income taxes (57,088) (33,203) (23,885) 71.9 %
Income taxes 115 40 75 187.5 %
Net loss $ (57,203) $ (33,243) $ (23,960) 72.1 %
Revenue
Revenue increased $33.3 million, or 40.6%, to $115.4 million for the year ended December 31, 2020 compared to the year ended December 31, 2019. The increase was attributable to an increase in sales of our Inspire system of $32.4 million in the U.S. and an increase of $0.9 million in Europe, primarily in Germany. Beginning in March 2020, our revenue growth in the U.S. and Europe has been impacted by the COVID-19 pandemic, which disrupted our ability to access our clinician customers and their patients. Specifically, we saw healthcare facilities and clinics restricting access to their clinicians, reducing patient consultations and treatments, or closing temporarily due to COVID-19. As a result, beginning in the second week of March 2020, substantially all of our Inspire therapy procedures were postponed and numerous other cases, which had received prior authorization, were not able to be scheduled and, therefore were also postponed. During the second quarter, the widespread shutdown in elective surgical procedures continued, but surgical volumes began increasing in May and even further in June, though still remaining below pre-COVID-19 levels. During the third and fourth quarters 2020, surgical volumes increased steadily, but remained negatively impacted by the COVID-19 pandemic, and the backlog of cases from the first half of 2020 was largely eliminated.
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Revenue information by region is summarized as follows:
Year Ended December 31,
2020 2019 Change
Amount % of Revenue Amount % of Revenue $ %
(in thousands, except percentages)
United States $ 106,108 92.0 % $ 73,660 89.8 % $ 32,448 44.1 %
Europe 9,273 8.0 % 8,390 10.2 % 883 10.5 %
Total revenue $ 115,381 100.0 % $ 82,050 100.0 % $ 33,331 40.6 %
Revenue generated in the U.S. was $106.1 million for the year ended December 31, 2020, an increase of $32.4 million, or 44.1%, over the year ended December 31, 2019. Revenue growth in the U.S. was due to increased market penetration in existing territories, the expansion into new territories, increased physician and patient awareness of our Inspire system, a greater number of prior authorization approvals, additional positive coverage policies and, to a lesser extent, an increase in our average selling price as a result of the introduction of the new sensing lead on the Inspire system to the U.S. market in February 2019. As noted above, U.S. revenue for the year ended December 31, 2020 was negatively impacted by the COVID-19 pandemic.
Revenue generated in Europe was $9.3 million in the year ended December 31, 2020, an increase of $0.9 million, or 10.5%, over the year ended December 31, 2019. Revenue growth in Europe was primarily due to increased market penetration in existing territories, the expansion of our European sales representatives into new territories, and increased physician and patient awareness of our Inspire system. The remainder of our revenue from Europe increase was due to favorable exchange rates. The overall growth was partially offset by impacts from the COVID-19 pandemic.
Cost of Goods Sold and Gross Margin
Cost of goods sold increased $4.0 million, or 29.2%, to $17.6 million for the year ended December 31, 2020 compared to $13.6 million for the year ended December 31, 2019. The increase was primarily due to product costs associated with higher sales volume of our Inspire system.
Gross margin was 84.7% for the year ended December 31, 2020 compared to 83.4% for the year ended December 31, 2019. Gross margin for the year ended December 31, 2020 was higher primarily due to manufacturing efficiencies and higher sales volume.
Research and Development Expenses
Research and development expenses increased $13.3 million, or 103.2%, to $26.1 million for the year ended December 31, 2020 compared to $12.8 million for the year ended December 31, 2019. This change was primarily due to an increase of $9.7 million for ongoing research and development costs, including ongoing development of the next generation Inspire therapy system, our Bluetooth remote, and the Inspire Cloud, $3.4 million of compensation and employee-related expenses, mainly as a result of increased headcount and stock-based compensation expense, and $0.2 million of regulatory submissions and clinical studies expenses.
Selling, General and Administrative Expenses
Selling, general and administrative expenses increased $37.4 million, or 41.4%, to $127.9 million for the year ended December 31, 2020 compared to $90.5 million for the year ended December 31, 2019. The primary driver of this increase was an increase of $25.9 million in compensation, including salaries, commissions, and stock-based compensation, and other employee-related expenses, mainly as a result of increased headcount, offset by a decrease of $2.5 million of travel expenses not incurred due to the COVID-19 pandemic. In addition, marketing expenses increased $9.5 million, primarily consisting of direct-to-consumer initiatives, including TV advertisements which began airing in the second half of 2019. During the year ended December 31, 2020, we initially refocused our direct-to-consumer marketing strategies by shifting from radio and TV in our larger markets
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that were affected by COVID-19 towards more digital and TV in smaller markets. During the second quarter of 2020, we resumed radio and TV initiatives in our larger markets as the impact of COVID-19 lessened in those areas. Further, our team leveraged virtual tools, including the new Inspire Sleep app released in the second quarter of 2020, and online tools to continue physician training and patient education. Other drivers of the increase to selling, general and administrative expenses included an increase of $2.0 million due to consulting fees, insurance costs, and information technology supplies and equipment.
Other Expense (Income), Net
Other expense (income), net changed by $2.6 million, or 151.9%, to $0.9 million of expense for the year ended December 31, 2020 compared to $1.7 million of income for the year ended December 31, 2019. This change was primarily due to a decrease of $2.7 million in interest income for the year ended December 31, 2020 due to lower interest rates on our cash, cash equivalents and investments balances, partially offset by a $0.1 million increase in gain on investments.
Income Taxes
We recorded a $0.1 million provision for income taxes for the year ended December 31, 2020 compared to less than $0.1 million for the year ended December 31, 2019. This increase was due to state income tax expense and an accrual for uncertain tax benefits.
Year Ended December 31, 2019 Compared to Year Ended December 31, 2018
For a discussion of our results of operations for the year ended December 31, 2018, including a year-to-year comparison between 2019 and 2018, refer to Part II, Item 7, "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our Annual Report Form 10-K for the year ended December 31, 2019.
Liquidity and Capital Resources
As of December 31, 2020, we had cash, cash equivalents and investments of $234.4 million and an accumulated deficit of $237.3 million, compared to cash, cash equivalents and investments of $155.7 million and an accumulated deficit of $180.2 million as of December 31, 2019. As of December 31, 2020, we had $24.5 million of outstanding borrowings under our credit facility. No borrowings remain available under this credit facility.
Our sources of capital have historically been from private placements of our convertible preferred securities, sales of our Inspire system, borrowings under credit facilities and registered offerings of our common stock. In April 2020, we completed a follow-on offering that included our offer and sale of 2,300,000 shares of common stock at a public offering price of $58.00 per share. We received net proceeds of approximately $124.7 million after deducting underwriting discounts, commissions, and offering expenses. As of December 31, 2020, we had raised a total of $119.1 million in net proceeds from private placements of our convertible preferred securities and $306.5 million from registered equity offerings.
The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and created significant volatility and disruption of financial markets. An extended period of global supply chain and economic disruption could materially affect our business, results of operations, access to sources of liquidity and financial condition. However, we believe that our existing cash resources will be sufficient to meet our capital requirements and fund our operations for at least the next 12 months. We may also seek liquidity through additional securities offerings or through borrowings under a new credit facility. We cannot ensure investors that we will be able to obtain such financing on commercially reasonable terms if at all.
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Cash Flows
The following table presents a summary of our cash flow for the periods indicated:
Year Ended December 31,
2020 2019
(in thousands)
Net cash provided by (used in):
Operating activities $ (53,045) $ (32,846)
Investing activities 86,627 (43,559)
Financing activities 134,065 1,964
Effect of exchange rate on cash 11 13
Increase (decrease) in cash and cash equivalents $ 167,658 $ (74,428)
Operating Activities
Net cash used in operating activities was $53.0 million for 2020 and consisted of a net loss of $57.2 million, an increase in net operating assets of $10.9 million, and non-cash charges of $15.0 million. The non-cash charges consisted of stock-based compensation, non-cash lease expense, depreciation and amortization, stock issued for services rendered, and accretion of the debt discount, offset by the non-cash income related to the accretion of the investment discount, and other, net. Operating assets includes accounts receivable, which increased due to higher sales, and inventories, which increased due to continued manufacturing of systems inventory as sales volumes increase. Operating liabilities includes accounts payable which increased generally due to the costs to support the growth of our operations, including compensation and personnel-related costs. Accrued expenses also increased due to the accrued compensation for annual bonuses to be paid during the first quarter of 2021.
Net cash used in operating activities was $32.8 million for 2019 and consisted of a net loss of $33.2 million, an increase in net operating assets of $6.6 million, and non-cash charges of $7.0 million. The non-cash charges consisted of stock-based compensation, accretion of the debt discount, non-cash lease expense, stock issued for services rendered, and depreciation and amortization, offset by the non-cash income related to the accretion of the investment discount, and other, net. Operating assets, which includes accounts receivable, inventories, and prepaid expenses and other current assets, increased generally due to increased revenues year-over-year. Operating liabilities, which includes accrued expenses and accounts payable, increased generally due to our increased business volume year-over-year and the costs to support the growth of our operations, including compensation and personnel-related costs.
Investing Activities
Net cash provided by investing activities for 2020 was $86.6 million and consisted primarily of proceeds from sales or maturities of investments of $141.8 million, partially offset by purchases of investments of $52.7 million and purchases of property and equipment of $2.5 million.
Net cash used in investing activities for 2019 was $43.6 million and consisted primarily of purchases of investments of $178.1 million, partially offset by proceeds from sales or maturities of investments of $137.3 million. Purchases of property and equipment were $2.7 million.
Financing Activities
Net cash provided by financing activities was $134.1 million for 2020 and consisted primarily of $124.7 million in proceeds from our follow-on offering in April 2020. The remainder of the cash provided by financing activities resulted from $7.1 million in proceeds from the exercise of stock options and $2.4 million in proceeds from the issuance of common stock from our employee stock purchase plan ("ESPP").
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Net cash provided by financing activities was $2.0 million for 2019 and consisted of $1.4 million in proceeds from the issuance of common stock from our ESPP and $1.1 million in proceeds from the exercise of stock options and warrants, partially offset by a $0.5 million final payment fee due upon the amendment of our credit facility.
Indebtedness
In August 2015, we entered into a loan and security agreement with Oxford Finance, as lender and collateral agent. The loan and security agreement initially provided for a term A loan facility in the amount of $15.5 million, which was fully funded on the closing date, and a term B loan facility in an amount of at least $3.5 million but no more than $10.0 million, to be available in the future subject to our achievement of certain revenue milestones. We refer to our term A loan facility and our term loan B facility together as our credit facility. In February 2017, we amended the loan and security agreement to, among other things, increase borrowings under the term A loan facility by $1.0 million, increase the minimum amount of the term B loan facility to $5.0 million and reduce the maximum amount of the term B loan facility to $9.0 million. In February 2018, we borrowed an additional $8.0 million under the term B loan facility portion of the credit facility. As of December 31, 2020, we had $24.5 million of outstanding borrowings under our credit facility. No borrowings remain available under this credit facility.
In March 2019, we amended the loan and security agreement. Following such amendment, outstanding borrowings under the credit facility bear interest at an annual rate equal to the sum of (i) the greater of (A) the 30 day U.S. LIBOR rate reported in The Wall Street Journal on the last business day of the month that immediately precedes the month in which the interest will accrue or (B) 2.50%, plus (ii) 5.10%; provided, however, under no circumstances will the basic rate be less than 7.60%. We are required to make monthly payments of interest only through April 1, 2022. Following the interest-only period, we will be required to make monthly payments of interest and principal in 24 consecutive monthly installments. Outstanding borrowings under the credit facility mature on March 1, 2024. On the maturity date, in addition to our regular monthly payments of principal and accrued interest, we will be required to make a payment of 3.50% of the total amount borrowed under the credit facility, which we refer to as the Final Payment, unless we have already made such payment in connection with an acceleration or prepayment of borrowings under the credit facility.
Borrowings under the facility are pre-payable at our option in whole, but not in part, together with all accrued and unpaid interest thereon and, if not previously made, the Final Payment (as defined in the loan and security agreement), subject to a prepayment fee of 2.0% if such borrowings are prepaid prior to March 27, 2021 and 1.0% if such borrowings are on or after March 27, 2021 and prior to maturity. We are also required to prepay the amounts outstanding under the credit facility upon the occurrence of certain customary events of default, as well as the occurrence of certain material adverse events. The credit facility also includes certain customary affirmative and negative covenants, but does not include any financial covenants. The credit facility is secured by substantially all of our personal property other than our intellectual property. We were in compliance with all covenants under the credit facility as of December 31, 2020.
In August 2015, we issued to Oxford Finance warrants to purchase 12,404 and 17,176 shares of our Series E convertible preferred stock, having an exercise price of $2.62 per share. In February 2017 and February 2018, we issued warrants to Oxford Finance to purchase 29,197 and 233,577 shares, respectively, of our Series F convertible preferred stock, having an exercise price of $1.37 per share. Each of the warrants described above has a term of 10 years.
Upon the closing of the IPO, the warrants to purchase 630,372 shares of preferred stock at a weighted average exercise price of $1.46 per share became exercisable to purchase 100,558 shares of common stock at a weighted average exercise price of $9.38 per share. Warrants to purchase 93,963 shares of common stock were exercised during 2018, and the warrants to purchase the remaining 6,595 shares of common stock were exercised during 2019. No warrants remain outstanding at December 31, 2020.
Off-Balance Sheet Arrangements
We do not have any off-balance sheet arrangements, as defined by applicable regulations of the SEC, that are reasonably likely to have a current or future material effect on our financial condition, results of operations, liquidity, capital expenditures or capital resources.
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Contractual Obligations and Commitments
Our contractual obligations and commitments as of December 31, 2020 are summarized in the table below:
Payments Due by Year
($ in thousands) Total Less than
1 year
1 - 3 years 3 - 5 years More than
5 years
Recorded contractual obligations:
Long-term debt (1)
$ 24,500 $ — $ 21,438 $ 3,062 $ —
Operating lease liabilities 7,423 17 1,805 2,449 3,152
Unrecorded contractual obligations:
Interest payments on long-term debt (2)
4,325 1,887 2,398 40 —
Purchase obligations 72,704 50,517 22,187 — —
Total contractual obligations $ 108,952 $ 52,421 $ 47,828 $ 5,551 $ 3,152
(1) Represents principal payments only. See Note 5 to our audited financial statements for additional information.
(2) Variable interest is assumed at December 31, 2020 rates. Under the terms of the loan and security agreement, a final payment fee of 3.50% is due at the earlier of maturity or prepayment. This amount is not included in the table above.
Critical Accounting Policies and Estimates
The preparation of the financial statements in conformity with accounting principles generally accepted in the U.S. requires management to make estimates and assumptions that affect the amounts reported in the audited financial statements and accompanying notes included elsewhere in this Annual Report on Form 10-K. We believe that such estimates have been based on reasonable and supportable assumptions and the resulting estimates are reasonable for use in the preparation of the audited financial statements. Actual results could differ from these estimates.
Significant areas requiring management estimates or judgments include the following key financial areas:
Revenue Recognition
We recognize revenue in accordance with Accounting Standards Codification ("ASC") Topic 606, Revenue from Contracts with Customers ("ASC 606"), which we adopted effective January 1, 2019 using the modified retrospective approach. The adoption of ASC 606 did not have a material impact on the amount and timing of revenue recognized in our financial statements.
Revenues from product sales are recognized when the customer obtains control of the product, which occurs at a point in time, either upon shipment of the product or receipt of the product, depending on shipment terms. Our standard shipping terms are free on board shipping point, unless the customer requests that control and title to the inventory transfer upon delivery. In those cases where shipping and handling costs are billed to customers, we classify the amounts billed as a component of cost of goods sold.
Revenue is measured as the amount of consideration we expect to receive, adjusted for any applicable estimates of variable consideration and other factors affecting the transaction price, which is based on the invoiced price, in exchange for transferring products. All revenue is recognized when we satisfy our performance obligations under the contract. The majority of our contracts have a single performance obligation and are short term in nature.
Sales taxes and value added taxes in foreign jurisdictions that are collected from customers and remitted to governmental authorities are accounted for on a net basis and therefore are excluded from net sales. Shipping and handling costs associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold.
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Variable consideration related to certain customer sales incentives is estimated based on the amounts expected to be paid based on the agreement with the customer using probability assessments.
We offer customers a limited right of return for our product in case of non-conformity or performance issues. We estimate the amount of our product sales that may be returned by our customers based on historical sales and returns. As our historical product returns to date have been immaterial, we have not recorded a reduction in revenue related to variable consideration for product returns.
Stock-Based Compensation
We maintain an equity incentive plan to provide long-term incentives for eligible employees, consultants, and members of the board of directors. The plan allows for the issuance of non-statutory and incentive stock options to employees and non-statutory stock options to consultants and directors. We also offer an employee stock purchase plan which allows participating employees to purchase shares of our common stock at a discount through payroll deductions.
We recognize equity-based compensation expense for awards of equity instruments to employees and directors based on the grant date fair value of those awards in accordance with ASC Topic 718, Stock Compensation ("ASC 718"). ASC 718 requires all equity-based compensation awards to employees and directors, including grants of restricted shares and stock options, to be recognized as expense in the statements of operations and comprehensive loss based on their grant date fair values. We estimate the fair value of stock options using the Black-Scholes option pricing model. The fair value of each purchase under the employee stock purchase plan is estimated at the beginning of the offering period using the Black-Scholes option pricing model. We have not granted any restricted shares. We have not granted any stock-based awards to our consultants.
The Black-Scholes option pricing model requires the input of certain subjective assumptions, including (i) the expected share price volatility, (ii) the expected term of the award, (iii) the risk-free interest rate and (iv) the expected dividend yield. Due to the lack of a public market for the trading of our common stock and a lack of company-specific historical and implied volatility data, we have based our estimate of expected volatility on the historical volatility of a group of similar companies that are publicly traded. The historical volatility is calculated based on a period of time commensurate with the expected term assumption. The group of representative companies have characteristics similar to us, including stage of product development and focus on the life science industry. We use the simplified method, which is the average of the final vesting tranche date and the contractual term, to calculate the expected term for options granted to employees and directors as we do not have sufficient historical exercise data to provide a reasonable basis upon which to estimate the expected term. The risk-free interest rate is based on a U.S. government Treasury instrument whose term is consistent with the expected term of the stock options. We use an assumed dividend yield of zero as we have never paid dividends and have no current plans to pay any dividends on our common stock.
We expense the fair value of our equity-based compensation awards granted to employees and directors on a straight-line basis over the associated service period, which is generally the period in which the related services are received. We account for award forfeitures as they occur.
Inventories
Inventories are valued at the lower of cost or net realizable value, computed on a first-in, first out basis. We estimate the recoverability of our inventory by reference to internal estimates of future demands and product life cycles, including expiration of inventory prior to sale. We regularly review inventory quantities on-hand for excess and obsolete inventory and, when circumstances indicate, incur charges to write down inventories to their net realizable value. The determination of a reserve for excess and obsolete inventory involves management exercising judgment to determine the required reserve, considering future demand, product life cycles, introduction of new products and current market conditions. The reserve for excess and obsolete inventory was $0.1 million as of both December 31, 2020 and 2019.
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Income Taxes
We account for income taxes using the liability method. Under this method, deferred tax assets and liabilities are determined based on the differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates that will be in effect when the differences are expected to reverse. Valuation allowances against deferred tax assets are established, when necessary, to reduce deferred tax assets to the amounts expected to be realized. As we have historically incurred operating losses, we have recorded a full valuation allowance against our net deferred tax assets, and there is no provision for income taxes other than minimal state taxes and an accrual for uncertain tax benefits. Our policy is to record interest and penalties expense related to uncertain tax positions as other expense in the statements of operations and comprehensive loss.
Recent Accounting Pronouncements
A discussion of recent accounting pronouncements is included in Note 2 to our financial statements contained in this Annual Report on Form 10-K.