Pulmonx Corp 10-K

ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS You should read the following discussion and analysis of our financial condition and results of operations together with Part II, Item 6, “Selected Consolidated Financial Data” and our consolidated financial statements and the related notes included elsewhere in this Annual Report on Form 10-K. This discussion and analysis and other parts of this Annual Report on Form 10-K contain forward-looking statements based upon current beliefs, plans and expectations related to future events and our future financial performance that involve risks, uncertainties and assumptions, such as statements regarding our intentions, plans, objectives, expectations, forecasts and projections. Our actual results and the timing of selected events could differ materially from those anticipated in these forward-looking statements as a result of several factors, including those set forth under Part I, Item 1A, “Risk Factors” and elsewhere in this Annual Report on Form 10-K. Overview We are a commercial-stage medical technology company that provides a minimally invasive treatment for patients with severe emphysema, a form of chronic obstructive pulmonary disease (COPD). Our solution, which is comprised of the Zephyr Endobronchial Valve (Zephyr Valve), the Chartis Pulmonary Assessment System (Chartis System) and the StratX Lung Analysis Platform (StratX Platform), is designed to treat severe emphysema patients who, despite medical management, are still profoundly symptomatic and either do not want or are ineligible for surgical approaches. We estimate our solution currently addresses approximately 500,000 patients in the United States and 700,000 patients in select international markets, which represents a global market opportunity of approximately $12 billion. We have a compelling body of clinical evidence with over 100 scientific articles published regarding the clinical benefits of Zephyr Valves, including in The New England Journal of Medicine , The Lancet and the American Journal of Respiratory and Critical Care Medicine . Multiple randomized controlled clinical trials have demonstrated that patients selected with the Chartis System and successfully treated with Zephyr Valves have shown statistically and clinically significant improvements in lung function, exercise capacity and quality of life compared to medical management alone. In June 2018, we received pre-market approval (PMA) by the U.S. Food and Drug Administration (FDA) as a result of our breakthrough technology designation. The Zephyr Valve is now commercially available in more than 25 countries, with over 80,000 valves used to treat more than 20,000 patients through December 31, 2020. We have established reimbursement in major markets in North America, Europe and Asia Pacific and the Zephyr Valve has been included in treatment guidelines for COPD worldwide. We market and sell our products in the United States through a direct sales organization consisting of 45 sales territory managers as of December 31, 2020. Our sales territory managers are focused on promoting awareness and increasing adoption of our solution primarily among the approximately 800 pulmonologists performing interventional pulmonary procedures and across approximately 500 high volume hospitals in the United States. We are expanding our commercial operations in the United States while continuing to foster our international growth. We employ both direct and distributor-based sales models, with over 90% of our revenue generated in markets where we sell directly. In the United States, our solution is reimbursed based on established Category I Current Procedural Terminology (CPT) and ICD-10 Procedure Coding System (PCS) codes and associated APC and MS-DRG payment groupings. Current reimbursement in the United States is believed to cover the hospital costs of the procedure and related inpatient care. Commercial payors such as Aetna, Humana, Health Care Service Corporation have issued positive coverage policies for the Zephyr Valve, and United Healthcare no longer considers the procedure unproven or experimental. Medicare covers our solution for patients when medically necessary, and other commercial insurers are approving pre-authorization requests on a case-by-case basis. Outside the United States, our solution is covered by major health systems across much of Europe, Australia and South Korea. 118 Table of Contents We manufacture all our products at our headquarters located in Redwood City, California. This facility supports production and distribution operations, including manufacturing, quality control, raw material and finished goods storage. We have manufactured all our products at this facility for over ten years. We also store finished goods at secondary facilities. We seek to maintain higher levels of inventory to protect ourselves from supply interruptions and have an established distribution system for both U.S. and international customers. To date, we have financed our operations primarily through the sale of equity securities, debt financing arrangements and sales of our products. We have devoted substantially all of our resources to research and development activities related to our solution, including clinical and regulatory initiatives to obtain marketing approval, sales and marketing activities, and investing in general and administrative infrastructure. We generated revenue of $32.7 million, with a gross margin of 64.8% and a net loss of $32.2 million, for the year ended December 31, 2020 compared to revenue of $32.6 million and $20.0 million, with a gross margin of 68.8% and 61.4% and a net loss of $20.7 million and $18.5 million, for the years ended December 31, 2019 and December 31, 2018, respectively. As of December 31, 2020, we had an accumulated deficit of $242.7 million, cash and cash equivalents of $231.6 million, and $17.4 million of outstanding term loans and credit agreements, net of debt discount and debt issuance costs. On September 30, 2020, our Registration Statement on Form S-1 (File No. 333-248635) relating to our initial public offering (IPO), was declared effective by the Securities Exchange Commission, or SEC. Pursuant to the Registration Statement, we issued and sold an aggregate of 11,500,000 shares of common stock (inclusive of 1,500,000 shares pursuant to the exercise by the underwriters of their option) at a price of $19.00 per share for aggregate cash proceeds of $201.4 million, net of underwriting discounts, commissions and offering costs. The sale and issuance of 11,500,000 shares in the IPO closed on October 5, 2020. Upon the closing of the IPO on October 5, 2020, all outstanding shares of convertible preferred stock automatically converted into 17,797,026 shares of common stock. Subsequent to the closing of the IPO, there were no shares of preferred stock outstanding. We have invested heavily in product development. Our research and development activities have been centered on driving continuous improvements to our solution. We have also made significant investments in clinical studies to demonstrate the safety and efficacy of the Zephyr Valve and to support regulatory submissions. We intend to make significant investments building our sales and marketing organization by increasing the number of sales territory managers and continuing our marketing efforts in existing and new markets throughout the United States, Europe and Asia Pacific. We also intend to continue to make investments in research and development efforts to develop our next generation products and support our future regulatory submissions to increase our addressable market and to expand indications and new markets. Because of these and other factors, we expect to continue to incur net losses for the next several years and we expect to require substantial additional funding, which may include future equity and debt financings. Management believes that the Company’s existing cash and cash equivalents will allow the Company to continue its operations for at least the next 12 months from the issuance of our consolidated financial statements as of and for the year ended December 31, 2020. Impact of the COVID-19 Pandemic Since it was reported to have surfaced in December 2019, a novel strain of coronavirus (COVID-19) has spread across the world and has been declared a pandemic by the World Health Organization. Efforts to contain the spread of COVID-19 have been significant and governments around the world, including in the United States, Europe and Asia, have implemented travel restrictions, social distancing requirements, quarantines, stay-at-home orders and other significant measures which have also resulted in delay of clinical trials and FDA operations. Currently, the COVID-19 pandemic presents a substantial public health and economic challenge around the world and is adversely affecting our employees, including our sales force, hospitals, physicians, patients, communities and business operations, as well as contributing to significant volatility and negative pressure on the U.S. and world economy and in financial markets. 119 Table of Contents The COVID-19 pandemic has had a material adverse impact on our business, financial condition and results of operations by decreasing and delaying substantially all procedures performed using our products, and we expect the pandemic to continue to have a material adverse impact on our business, financial condition and results of operations for the foreseeable future. Similar to the general trend in elective and other surgical procedures, the number of procedures performed using our products has decreased substantially as healthcare organizations across the globe have prioritized the treatment of patients with COVID-19 or have altered their operations to prepare for and respond to the pandemic. In the markets in which we operate, elective, specialty and other procedures and appointments have been suspended or canceled to avoid non-essential patient exposure to medical environments and potential infection with COVID-19 and to focus limited resources and personnel capacity toward the treatment of COVID-19 patients. In response to the COVID-19 pandemic, we have implemented a variety of measures intended to help us manage through its impact and position us to resume operations quickly and efficiently as restrictions, recommendations, and best practices evolve. These measures include: • Establishing safety protocols, facility enhancements, and work-from-home strategies to protect our employees; • Ensuring that our manufacturing and supply chain operations remain intact and operational, and building over four months of inventory; • Keeping our workforce intact and continuing to build our team, including expansion of our U.S. sales force; • Continuing to focus on new account openings and implementing virtual physician and sales force training programs; • Accelerating our physician education programs and direct-to-patient marketing efforts through social media or other virtual forums; • Increasing our capital base by $201.4 million through an initial public offering of our common stock in October 2020; and • Continuing to invest in research and development activities in order to advance our AeriSeal clinical programs. The COVID-19 pandemic has also adversely impacted the number of procedures using the Zephyr Valve as hospitals have had to, and continue to, focus on COVID-19 and as patients generally sought to postpone healthcare visits and treatments. Specifically, beginning in the second half of March 2020, procedures using our products were temporarily postponed or cancelled as COVID-19 spread to the various regions across the globe where we conduct our business and sell our products. Beginning in May 2020, we began to see signs of a recovery in our business, and by September 30, 2020 the total number of Zephyr Valves sold in the third quarter exceeded the total number of Zephyr Valves sold during the first quarter of 2020. In November and December 2020, a resurgence of COVID-19 led to a decrease in procedure volumes and our revenues in the fourth quarter of 2020 declined compared to revenues in the third quarter of 2020. The COVID-19 driven impact on procedure volumes extended through the first two months of 2021. We have seen initial indicators in March 2021 that the resurgence of COVID-19 is diminishing and we anticipate improving sales during 2021, assuming the efficacy, availability and delivery of vaccines as well as other societal responses to the pandemic. We are encouraged for the longer term, and we believe the following key indicators are contributing to the stabilization of our business: • Continued opening of new accounts; • Strong physician participation in virtual trainings; 120 Table of Contents • A strong patient pipeline evidenced by an increase in StratX report activity near to pre-COVID-19 levels, a rebound in patient calls into hospitals inquiring about our procedure, and a resumption of patient calls to our reimbursement support service; and • Hospitals and centers beginning to accept patients for elective procedures. Despite these signs of recovery of our business, we cannot be certain that any recovery will be sustained, or that a further resurgence of COVID-19 will not occur in 2021. We believe many of the measures adopted in response to, and challenges resulting, from COVID-19 will likely continue for the duration of the pandemic, which is uncertain, and are expected to continue to significantly reduce our revenue and adversely impact our business, financial condition and results of operations for the duration of the pandemic. As a result, we cannot assure you that our recent volume of Zephyr Valves sold are indicative of future results or that we will not experience additional adverse or materially adverse impacts associated with the COVID-19 pandemic. In particular, we believe the reduction in the backlog of patients who cancelled or postponed their procedures in the second quarter of 2020 contributed to the number of procedures and Zephyr Valves sold in the third and fourth quarters of 2020 as hospitals and centers resumed accepting patients for elective procedures. However, the number of Zephyr Valves sold in the future may decrease as the backlog of patients who have cancelled or postponed their procedures due to the COVID-19 pandemic is reduced. Further, once the COVID-19 pandemic subsides, there may be a substantial backlog of patients seeking appointments with physicians and surgeries to be performed at hospitals relating to a variety of medical conditions, and as a result, patients seeking treatment with Zephyr Valves may have to navigate limited provider capacity. We believe this limited provider and hospital capacity could have a material adverse effect on our business, financial condition and results of operations once the pandemic subsides and following the end of the pandemic. The extent to which the COVID-19 pandemic impacts our business will depend on future developments, which are highly uncertain and cannot be predicted, including new information which may emerge concerning the severity and spread of COVID-19 and variant strains, governmental and societal response to contain and treat COVID-19 and variant strains, and vaccination efforts, among others. Our consolidated financial statements reflect judgments and estimates that could change in the future as a result of the COVID-19 pandemic. For more information regarding these risks and potential impacts, please refer to Part I, Item 1A, “Risk Factors.” Factors Affecting our Business and Results of Operations We believe there are several important factors that have impacted and that we expect will continue to impact our business and results of operations. These factors include: Our Ability to Recruit, Train and Retain Our Sales Force and its Productivity We have made, and intend to continue to make, significant investments in recruiting, training and retaining our direct sales force. This process requires significant education and training for our sales personnel to achieve the level of technical competency with our products that is expected by physicians and to gain experience building demand for our products. Upon completion of the training, our sales personnel typically require time in the field to grow their network of accounts and increase their productivity to the levels we expect. Successfully recruiting, training and retaining additional sales personnel will be required to achieve growth. In addition, inability to attract qualified sales personnel or the loss of any productive sales personnel would have a negative impact on our ability to grow our business. We have in the past and expect in the future to enter into different compensation arrangements with our sales professionals, which include minimum guaranteed commissions. This has impacted our compensation expenses in the past and we expect it will do so in the future. 121 Table of Contents Physician, Patient and Hospital Awareness and Acceptance of Our Solution Our goal is to establish our solution as a standard of care for severe emphysema. We intend to continue to promote awareness of our solution through training and educating physicians, pulmonary rehabilitation centers, key opinion leaders and various medical societies on the proven clinical benefits of Zephyr Valves. In addition, we intend to continue to publish additional clinical data in various industry and scientific journals and online and to present at various industry conferences. We plan to continue building patient awareness through our direct-to-patient marketing initiatives, which include advertising, social media and online education. We also intend to continue helping physicians in their outreach to patients and other healthcare providers. These efforts require significant investment by our marketing and sales organization, and vary depending upon the physician’s practice specialization, and personal preferences and geographic location of physicians, pulmonary rehabilitation centers and patients. In order to grow our business, we will need to continue to make significant investments in training and educating hospitals, physicians and patients on the advantages of our solution for the treatment of severe emphysema. Third-Party Reimbursement Since achieving regulatory approval in the United States in June 2018, we have launched the Zephyr Valve treatment and have made progress securing third-party payor reimbursement. The majority of our patients are Medicare beneficiaries. We estimate that roughly 75% of the potential Zephyr Valve patient population are Medicare/Medicaid beneficiaries, of which approximately 25% have managed Medicare/Medicaid and the remaining 50% have traditional Medicare/Medicaid. Approximately 25% of the potential Zephyr Valve patient population is under third-party commercial payor policies. A key element of our strategy remains to broaden our coverage by private third-party payor policies. Commercial payors such as Aetna, Humana, Health Care Service Corporation, and Highmark have issued positive coverage policies for the Zephyr Valve, and United Healthcare no longer considers the procedure unproven or experimental. Other commercial payors, such as many plans in the Blue Cross Blue Shield family of plans, do not yet consider our solution medically necessary, but these same plans are approving pre-authorization requests on a case-by-case basis. Medicare, currently without a public coverage policy, covers our solution for patients when medically necessary on a case-by-case basis and other commercial insurers not described above are approving pre-authorization requests on a case-by-case basis. We have a dedicated patient reimbursement support team in the United States that works collaboratively with patients and providers to help secure the appropriate prior authorization approvals in advance of treatment. We continue to educate private insurers in the United States on our clinical data and patient selection tools in an effort to continue to expand the number of positive coverage policies, in order to increase our revenue. Outside the United States, our solution is covered by major health systems across much of Europe, Australia and South Korea. Competition Our industry is highly competitive and subject to rapid change from the introduction of new products and technologies and other activities of industry participants. Our goal is to establish our solution as a standard of care for severe emphysema. Existing treatments include medical management, lung volume reduction surgery (LVRS), lung transplantation as well as other minimally invasive treatments. Some of our competitors have several competitive advantages, including established relationships with pulmonologists who commonly treat patients with emphysema, significantly greater name recognition and significantly greater sales and marketing resources. In addition to competing for market share, we also compete against these companies for personnel, including qualified sales and other personnel that are necessary to grow our business. Certain of our competitors may challenge our intellectual property, may develop additional competing or superior technologies and processes and compete more aggressively and sustain that competition over a longer period of time than we could. In addition to existing competitors, other companies may acquire or in-license competitive products and could directly compete with us. We must continue to successfully compete in light of our competitors’ existing and future products and related pricing and their resources to successfully market to the physicians who use our products. 122 Table of Contents Leveraging Our Manufacturing Capacity is Critical to Improving Our Gross Margin With our current operating model and infrastructure, we have the capacity to significantly increase our manufacturing production. If we grow our revenue and sell more units, our fixed manufacturing costs will be spread over more units, which we believe will reduce our manufacturing costs on a per-unit basis and in turn improve our gross margin. In addition, we intend to continue investing in manufacturing efficiencies in order to reduce our overall manufacturing costs. However, other factors will continue to impact our gross margins such as geographic mix, pricing and customer discounts, incentives, support services and potential seasonality. Investing in Research and Development to Foster Innovation to Expand Our Addressable Market We intend to continue investing in existing and next generation technologies to further improve our products and clinical outcomes, enhance patient selection and broaden the patient population that can be treated with our products. In addition, we are continuing to invest in the accuracy and features of our patient assessment tools. Moreover, we plan to conduct clinical research of AeriSeal, a potential product in development for the treatment of severe emphysema patients who are not qualified for Zephyr Valve treatment due to excessive collateral ventilation. While research and development and clinical testing are time consuming and costly, we believe that a pipeline of new products and product enhancements that improve efficacy, safety and cost effectiveness is critical to increasing the adoption of our solution. Seasonality Historically, we have experienced seasonality outside of the United States, primarily in the first and third quarters and anticipate this trend to continue. In addition, as our sales grow in the United States, we may experience seasonality based on holidays, vacations and other factors because this is an elective procedure. Components of Our Results of Operations Revenue We currently derive substantially all our revenue from the sale of our products to hospitals and distributors. We market and sell our products through a direct sales organization in the United States and through direct sales and several third-party distributors in select markets outside the United States. We currently generate most of our revenue from the sales of Zephyr Valves and delivery catheters. We also generate a smaller amount of our revenue from our Chartis System, which is comprised of sales of the balloon catheters, usage fees and sales of the Chartis console. The StratX Platform, while used to identify patients eligible for treatment with Zephyr Valves, does not independently generate any revenue for us. No single customer accounted for more than 10% of our revenue during the years ended December 31, 2020, 2019 and 2018. Revenue from sales of our products fluctuates based on volume of cases (procedures performed), the average number of Zephyr Valves used for a patient, pricing, discounts, incentives and mix of U.S. and international sales. Our revenue also fluctuates and in the future will continue to fluctuate from quarter-to-quarter due to a variety of factors, including the availability of reimbursement, the size and success of our sales force, the number of hospitals and physicians who are aware of and perform the procedures using our solution and seasonality. Our revenue from international sales may also be impacted by fluctuations in foreign currency exchange rates between the U.S. dollar (our reporting currency) and the local currency. Cost of Goods Sold and Gross Margin Cost of goods sold consists primarily of payroll and personnel-related expenses for our manufacturing and quality assurance employees, costs related to materials, components and subassemblies, third-party costs, manufacturing overhead, equipment depreciation, charges for excess, obsolete and non-sellable inventories. Overhead costs include the cost of quality assurance, testing, material procurement, inventory control, operations supervision and 123 Table of Contents management and an allocation facilities overhead cost, including rent and utilities. Cost of goods sold also includes certain direct costs such as those incurred for shipping our products and costs related to providing analysis services for patient scans. We record adjustments to our inventory valuation for estimated excess, obsolete and non-sellable inventories based on assumptions about future demand, past usage, changes to manufacturing processes and overall market conditions. We expect cost of goods sold to increase in absolute dollars to the extent more of our products are sold. We calculate gross margin as gross profit divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily by our manufacturing costs, pricing pressures and, to a lesser extent, the percentage of products we sell in the United States versus internationally and the percentage of products we sell to distributors versus directly to hospitals. Our gross margin is typically higher on products we sell directly to hospitals as compared to products we sell through distributors. Our gross margin may increase over the long term to the extent our production volume increases as our fixed manufacturing costs would be spread over a larger number of units, thereby reducing our per-unit manufacturing costs. We expect our gross margin to fluctuate from period to period, however, based upon the factors described above and seasonality. Operating Expenses Our operating expenses have consisted solely of research and development costs and selling, general and administrative costs. Research and Development Expenses Our research and development activities primarily consist of engineering and research programs associated with our products under development and improvements to our existing products. Research and development expenses include payroll and personnel-related costs for our research and development employees, including expenses related to stock-based compensation for employees engaged in research and development, consulting services, clinical trial expenses, regulatory expenses, prototyping, testing, laboratory supplies, and an allocation of facility overhead costs. Our clinical trial expenses include costs associated with clinical trial design, clinical trial site development and study costs, data management costs, related travel expenses, the cost of products used for clinical activities, and internal and external costs associated with our regulatory compliance. We expense research and development costs as they are incurred. We expect our research and development expenses, including related stock-based compensation expense, to increase in absolute dollars as we hire additional personnel to develop new product offerings and product enhancements. Selling, General and Administrative Expenses Our selling, general and administrative expenses consist of payroll and personnel-related costs for our sales and marketing personnel, including variable sales compensation, travel expenses, consulting, public relations costs, direct marketing, customer training, trade show and promotional expenses, stock-based compensation and allocated facility overhead costs, and for administrative personnel that support our general operations such as information technology, executive management, financial accounting, customer services and human resources personnel. We expense sales variable compensation at the time of the sale. Selling, general and administrative expenses also include costs attributable to professional fees for legal and accounting services, insurance, consulting fees, recruiting fees, travel expense, bad debt expense and depreciation. We intend to continue to increase the size of our sales force and our marketing spending to generate sales opportunities. We expect our sales and marketing expenses to increase in absolute dollars as we hire additional sales personnel and increase our sales support infrastructure and add additional marketing programs in order to more fully penetrate the global opportunity. We also expect our administrative expenses, including stock-based compensation expense, to increase as we increase our headcount and expand our facilities and information technology to support our operations as a public company. Additionally, we anticipate increased expenses related to audit, legal, regulatory 124 Table of Contents and tax-related services associated with being a public company, compliance with exchange listing and Securities and Exchange Commission (SEC) requirements, director and officer insurance premiums and investor relations costs. We also saw an increase in our stock-based compensation expense with the establishment of our new equity plan and related grants either in the form of restricted stock units or options. Our selling, general and administrative expenses may fluctuate from period to period due to the seasonality of our business and as we continue to add direct sales territory managers in new territories. Interest Expense and Income Interest expense consists primarily of interest expense related to our term loan facilities and convertible notes, including amortization of debt discount and issuance costs. Interest income is predominantly derived from investing surplus cash in money market funds and short-term marketable securities. Other Income (Expense), Net Other income (expense), net primarily consists of changes in the fair value of our derivative liabilities, changes in the fair value of our outstanding preferred stock warrants and foreign currency exchange gains and losses. In February 2020, the warrants were partly exercised and partly expired. The final fair value of the warrant liability was reclassified to stockholders’ (equity)/deficit. All of our derivative liabilities were settled during 2020. Upon the closing of our initial public offering on October 5, 2020, we paid $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC. In connection with the closing of the IPO, the 2020 Notes were converted into 2,561,484 shares of common stock. 125 Table of Contents Results of Operations: Comparison of the Years Ended December 31, 2020 and December 31, 2019 The following table summarizes our results of operations for the period indicated: Year Ended December 31, 2020 2019 $ Change % Change (in thousands) Revenue $ 32,733 $ 32,595 $ 138 0.4 % Costs of goods sold 11,531 10,181 1,350 13.3 % Gross profit 21,202 22,414 (1,212) (5.4) % Operating expenses: Research and development 7,460 6,049 1,411 23.3 % Selling, general and administrative 46,074 34,203 11,871 34.7 % Total operating expenses 53,534 40,252 13,282 33.0 % Loss from operations (32,332) (17,838) (14,494) 81.3 % Interest income 213 432 (219) (50.7) % Interest expense (3,181) (2,317) (864) 37.3 % Other income (expense), net 3,282 (617) 3,899 631.9 % Net loss before tax (32,018) (20,340) (11,678) 57.4 % Income tax expense 213 363 (150) (41.3) % Net loss $ (32,231) $ (20,703) $ (11,528) 55.7 % Revenue Revenue increased by $0.1 million, or 0.4%, to $32.7 million during the year ended December 31, 2020, compared to $32.6 million during the year ended December 31, 2019. The increase in revenue was due to an increase in the sale of products in the United States of $5.5 million to $16.2 million during the year ended December 31, 2020, compared to $10.7 million during year ended December 31, 2019. The increase in United States revenue was driven by increased sales of the Zephyr Valve as we expanded commercialization efforts. The gains in the US were offset by a decrease in the sale of products due to lower procedure volumes in international markets of $5.4 million to $16.5 million during the year ended December 31, 2020, compared to $21.9 million during the year ended December 31, 2019. Revenue in both the United States and international markets were unfavorably impacted by the COVID-19 pandemic, which decreased and delayed procedures performed using our products for much of the second quarter of 2020 before beginning to recover in the second half of the year. Cost of Goods Sold and Gross Margin Cost of goods sold increased by $1.4 million, or 13.3%, to $11.5 million during the year ended December 31, 2020, compared to $10.2 million during the year ended December 31, 2019. The increase was mainly due to lower manufacturing utilization in the second quarter of 2020 resulting from the response to the COVID-19 pandemic combined with increased manufacturing costs as we expanded headcount and invested in operational infrastructure to support anticipated future growth. The increase in cost of goods sold caused gross margin to decrease from 69% during the year ended December 31, 2019 to 65% during the year ended December 31, 2020. Research and Development Expenses Research and development expenses increased by $1.4 million, or 23.3%, to $7.5 million during the year ended December 31, 2020, compared to $6.0 million during the year ended December 31, 2019. The increase in research 126 Table of Contents and development expenses was primarily due to an increase of $1.2 million in personnel expenses including stock based compensation as we expanded our research and development team and $0.4 million of professional services and other expenses, offset by a $0.2 million decrease in costs associated with our clinical trials, including fees paid to contract research organizations due to reduced clinical trial activity during the year ended December 31, 2020. Selling, General and Administrative Expenses Selling, general and administrative expenses increased by $11.9 million, or 34.7%, to $46.1 million during the year ended December 31, compared to $34.2 million during the year ended December 31, 2019. This increase in selling, general and administrative expenses was primarily due to an increase of $3.0 million resulting from the write-off of deferred initial public offering costs in the second quarter of 2020, $5.6 million of payroll and personnel-related expenses including stock based compensation as we expanded our sales and marketing function, an increase of $2.6 million of payroll and personnel-related expenses including stock based compensation for our administrative personnel due to increased headcount, an increase of $0.9 million in advertising expenses, an increase of $0.7 million in insurance costs associated with being a public company, and an increase of $1.0 million in facility and other expenses. These increases were offset by a decrease of $1.9 million in global travel and conference related expenses which were impacted by the COVID-19 pandemic. Interest Expense and Income Interest expense increased by $0.9 million, or 37.3%, to $3.2 million during the year ended December 31, 2020, compared to $2.3 million during the year ended December 31, 2019 primarily due to an increase in borrowings under the CIBC Term Loan and the 2020 Notes partially offset by the repayment of the Oxford Term Loan. Interest income decreased by $0.2 million for the year ended December 31, 2020 compared to the year ended December 31, 2019, which was primarily due to decreased marketable securities balances throughout most of the year. Other Income (Expense), Net Other income (expense), net increased by $3.9 million to $3.3 million during the year ended December 31, 2020, compared to ($0.6) million during the year ended December 31, 2019, primarily attributable to the closing of our IPO leading to favorable fair value adjustments of derivative liabilities. 127 Table of Contents Comparison of the Years Ended December 31, 2019 and December 31, 2018 The following table summarizes our results of operations for the period indicated: Years Ended December 31, 2019 2018 $ Change % Change (in thousands) Revenue $ 32,595 $ 20,004 $ 12,591 62.9 % Costs of goods sold 10,181 7,718 2,463 31.9 % Gross profit 22,414 12,286 10,128 82.4 % Operating expenses: Research and development 6,049 6,991 (942) (13.5) % Selling, general and administrative 34,203 20,347 13,856 68.1 % Total operating expenses 40,252 27,338 12,914 47.2 % Loss from operations (17,838) (15,052) (2,786) 18.5 % Interest income 432 21 411 — Interest expense (2,317) (2,520) 203 (8.1) % Other income (expense), net (617) (916) 299 (32.6) % Net loss before tax (20,340) (18,467) (1,873) 10.1 % Income tax expense 363 12 351 — Net loss $ (20,703) $ (18,479) $ (2,224) 12.0 % Revenue Revenue increased by $12.6 million, or 62.9%, to $32.6 million during the year ended December 31, 2019, compared to $20.0 million during the year ended December 31, 2018. The increase in revenue was due to an increase in the sale of products in the United States by $10.1 million from $0.6 million for the year ended December 31, 2018 to $10.7 million for the year ended December 31, 2019 and an increase in the sale of products in international markets by $2.5 million from $19.4 million for the year ended December 31, 2018 to $21.9 million for the year ended December 31, 2019. We obtained FDA approval for the Zephyr Valves in the United States in June 2018 and began generating revenue in the United States in the third quarter of 2018. Overall, there was an increase in the number of units of products sold for the year ended December 31, 2019 as compared to the year ended December 31, 2018. Unit growth paralleled the growth in revenue dollars for 2019 while average selling prices maintained their 2018 levels showing a small improvement. Cost of Goods Sold and Gross Margin Cost of goods sold increased by $2.5 million, or 31.9%, to $10.2 million during the year ended December 31, 2019, compared to $7.7 million during the year ended December 31, 2018. The increase was primarily due to growth in sales volume and additional manufacturing overhead costs as we invested in our operational infrastructure to support anticipated future growth. Our gross margin increased from 61.4% for the year ended December 31, 2018 to 68.8% for the year ended December 31, 2019. The increase in gross margin was primarily due to lower fixed costs per unit from the increased sales volume of our products. Research and Development Expenses Research and development expenses decreased by $0.9 million, or 13.5%, to $6.0 million during the year ended December 31, 2019, compared to $7.0 million during the year ended December 31, 2018. The decrease in research and development expenses was primarily due to a decrease of $0.7 million of costs associated with our clinical trials, 128 Table of Contents including fees paid to contract research organizations (CROs) and consulting costs due to lower clinical trial activity during the year ended December 31, 2019. Selling, General and Administrative Expenses Selling, general and administrative expenses increased by $13.9 million, or 68.1%, to $34.2 million during the year ended December 31, 2019, compared to $20.3 million during the year ended December 31, 2018. This increase in selling, general and administrative expenses was primarily due to an increase of $8.8 million of payroll and personnel-related expenses for our sales personnel, an increase of $1.0 million of payroll and personnel-related expenses for our administrative personnel, an increase of $2.0 million of professional fees for legal, consulting, accounting, tax and other services, an increase of $1.2 million of travel related expenses and $0.4 million of advertising and marketing materials. Interest Expense and Income Interest expense decreased by $0.2 million, or 8.1%, to $2.3 million during the year ended December 31, 2019, compared to $2.5 million during the year ended December 31, 2018 primarily due to lower interest on convertible note payable to a related party because our convertible debt from Boston Scientific Corporation (BSC) converted into shares of our Series G-1 preferred stock in April 2019. Interest income increased by $0.4 million from the year ended December 31, 2018 to the year ended December 31, 2019 primarily due to interest income on proceeds from issuance of Series G-1 preferred stock invested in cash equivalents and short-term marketable securities. Other Income (Expense), Net Other income (expense), net decreased by $0.3 million, or 32.6%, to $0.6 million during the year ended December 31, 2019, compared to $0.9 million during the year ended December 31, 2018, primarily due to lower net foreign exchange losses of $0.1 million. Liquidity and Capital Resources; Plan of Operation To date, we have financed our operations primarily through private placements of equity securities, debt financing arrangements and sales of our products. As of December 31, 2020, we had cash and cash equivalents of $231.6 million, an accumulated deficit of $242.7 million, and $16.8 million outstanding under the CIBC Term Loan, net of debt discount. Oxford Term Loan From August 2014 until February 2020, we were party to a Loan and Security Agreement with Oxford (Oxford Agreement), which provided us with the ability to borrow up to $20.0 million in term loans. The Oxford Agreement included a floating interest rate tied to LIBOR and included customary representations and warranties, restrictive covenants, events of default and other customary terms and conditions. As of December 31, 2019, the Company was in default with a covenant in the Oxford Agreement resulting from its failure to maintain cash balances outside the United States within the levels set forth in the Oxford Agreement. This event of default was waived by Oxford. The loan was collateralized by a first-priority lien on substantially all of our assets, including cash and cash equivalents, accounts receivable, intellectual property and equipment. In May 2017, we entered into an amendment to the Oxford Agreement, and in May 2018 we entered into two additional amendments. Each of the amendments extended the “interest only period” under the loan, during which the loan accrued interest, but were not required to make principal payments. In connection with the closing of the Oxford Agreement in August 2014, we also entered into a Success Fee Agreement, which requires us to pay up to $2.5 million (the Success Fee) in the event of a sale or other disposition by us of all or substantially all of our assets, a merger or consolidation or an initial public offering (a Liquidity Event), in each case before August 28, 2021. We borrowed a total of $15.0 million principal amount of term loans 129 Table of Contents under the Oxford Agreement, which based on the formula in the Success Fee Agreement, obligated us to pay a Success Fee of $1.9 million on the closing of our IPO in October 2020. In 2020, 2019 and 2018, we recorded interest expense on the term loan of $0.4 million, $1.7 million and $1.7 million, respectively. We incurred fees and legal expenses of $0.1 million in connection with the Oxford Agreement and related Amendments, which were recorded as deferred financing costs and amortized to interest expense. We also paid $0.2 million in fees to Oxford which is reflected as a discount on the debt and was being accreted over the life of the term loan. In 2020, 2019 and 2018, we recorded interest expense related to deferred financing and debt issuance costs of less than $0.1 million, respectively. In February 2020, we terminated and paid off in full $17.3 million, including the outstanding loan amount of $15.0 million, final payment of $1.3 million, amendment fees of $0.9 million and accrued interest of $0.1 million, outstanding under the Oxford Agreement. The repayment of the loans under the Oxford Agreement was accounted as extinguishment and the Company recorded a loss on debt extinguishment of $0.4 million. All of our obligations under the Oxford Agreement have been terminated except the indemnity obligation thereunder, which by their terms survive the facility. On October 5, 2020, upon the closing of our IPO, we paid $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC. Loan and Security Agreement with Boston Scientific Corp (BSC) From May 2017 until January 2020, we were party to a Second Lien Loan and Security Agreement with Boston Scientific Corp (BSC Agreement), which provided us with the ability to borrow up to $30.0 million in term loans. The BSC Agreement included a fixed interest rate of 8.96% and included customary representations and warranties, restrictive covenants, events of default and other customary terms and conditions. The BSC Agreement provided for principal and accrued interest on the loans to convert into our stock at BSC’s option upon completion by us of any Qualified Equity or Debt Financing, or the occurrence of any Change of Control or Liquidation (each term as defined in the BSC Agreement). In conjunction with the BSC Agreement, we and BSC entered into a No Shop Agreement such that from the date of execution of the agreement through the earlier of ten days following receipt by BSC of a letter confirming our submission of the final module of our PMA application to the FDA and March 31, 2018, we would not sign a term sheet or engage in discussions to sell our company. The No Shop Agreement terminated in 2018. In addition, BSC’s Right of First Negotiation, originally received as part of BSC’s investment in our Series F-1 Preferred Stock, was amended to shorten the period it has to exercise its Right of First Negotiation from ten to five business days, and to shorten the exclusive negotiation period from 75 to 45 days with respect to the initial notice from us that we intend to pursue a change in control or an initial public offering. For subsequent notices from us, BSC has ten days to exercise its right of first negotiation, and 75 days to enter into definitive agreements for a change in control transaction. We provided an initial notice to BSC of our intention to pursue our initial public offering and BSC declined to exercise its Right of First Negotiation. BSC’s Right of First Negotiation terminated in connection with the closing of our IPO in October 2020. We borrowed $6.0 million in 2017, $12.0 million in 2018 and $6.0 million in January 2019 under the BSC Agreement. We incurred fees and legal expenses of $0.1 million in connection with the BSC Agreement, which are reported on the balance sheet as a direct deduction from the face amount of the convertible note. Amortization of the issuance costs are calculated using the effective interest rate method over the term of the note and recorded as a non-cash interest expense. In 2018, we recorded interest expense of $0.8 million. 130 Table of Contents In April 2019, all outstanding indebtedness and accrued interest under the BSC Agreement converted into shares of our Series G-1 preferred stock. At December 31, 2019, we retained the ability to draw up to an additional $6.0 million under the BSC Agreement until the maturity date in May 2022. We terminated the BSC Agreement in January 2020, which terminated all of our obligations under the BSC Agreement except the indemnity obligation thereunder, which by their terms survive the facility. CIBC Term Loan On February 20, 2020, we executed a Loan and Security Agreement with Canadian Imperial Bank of Commerce (CIBC), which we subsequently amended on April 17, 2020 and December 28, 2020 (as amended, the CIBC Agreement). The CIBC Agreement provided us with the ability to borrow up to $32.0 million in debt financing consisting of $17.0 million advanced at the closing of the agreement (Tranche A), with the option to draw up to an additional $8.0 million (Tranche B) on or before February 20, 2022 and an additional $7.0 million (Tranche C) on or before February 20, 2022. Tranche B is conditioned upon achieving a trailing six-month revenue of at least $15.0 million as of the date of any Tranche B Borrowing, and Tranche C is conditioned upon achieving a trailing six-month revenue of at least $20.0 million as of the date of any Tranche C borrowing. The availability of Tranche B and Tranche C is further conditioned upon the joining of Pulmonx International Sàrl to the CIBC Agreement and the execution by Pulmonx International Sàrl of Swiss-law collateral documentation in favor of CIBC. The loan will mature on March 15, 2022. However, the loan’s maturity will automatically be extended to February 20, 2025 if we amend the 2020 Notes such that the 2020 Notes mature on May 21, 2025 or later or if all of the convertible notes are converted to preferred stock, in each case prior to March 1, 2022 and if no event of default exists under the CIBC Agreement. If the loan’s maturity is extended to 2025, equal monthly principal payments will begin after a 24-month interest only grace period. The interest only grace period can extend to 36 months if we achieve three-month trailing revenue of at least $20.0 million as of February 20, 2022. The loan bears interest at a floating rate equal to 1.0% above the Wall Street Journal Prime Rate at any time. The Tranche C loan will bear interest at a floating rate equal to 1.5% above the Wall Street Journal Prime Rate at any time. The loan is collateralized by substantially all of our assets, including cash and cash equivalents, accounts receivable, intellectual property and equipment. We may prepay the loan, subject to certain requirements. The CIBC Agreement includes customary restrictive covenants, financial covenants, events of default and other customary terms and conditions. In December 2020, to address certain post-close covenants for which we were not in compliance, we entered into a Second Amendment to the CIBC Agreement that extended the compliance date for certain post-close covenants to June 30, 2021. We paid $0.3 million fees to the lender and third parties which is reflected as a discount on the CIBC Loan and is being accreted over the life of the term loan using the effective interest method. During the year ended December 31, 2020, we recorded interest expense related to debt discount and debt issuance costs of CIBC Loan of $0.1 million. Interest expense on the CIBC Loan amounted $0.7 million during the year ended December 31, 2020. 2020 Notes In April 2020, we issued and sold the 2020 Notes in the aggregate principal amount of $33.0 million. We have the option to call up to an additional $33.0 million for a maximum aggregate amount of $66.0 million, subject to customary closing conditions, provided that any such call be for no less than $5.0 million on or prior to April 17, 2022. The 2020 Notes accrue interest at a rate equal to 2.0% above the Wall Street Journal Prime Rate. All unpaid interest and principal will be due and payable upon request of the majority of lenders (Majority Holders) on or after the earlier of April 17, 2022 or an event of default. The Company may prepay the 2020 Notes prior to April 17, 2022 only with the consent of the Majority Holders. Upon an initial public offering which results in net proceeds of not less than $30.0 million (a Qualified IPO), the outstanding 2020 Notes and any unpaid accrued interest shall automatically convert in whole into shares of our common stock at a conversion price equal to the lesser of (i) price per share paid for common stock in the Qualified 131 Table of Contents IPO multiplied by either 85% if the conversion takes place within 18 months of the Initial Closing, or 80% otherwise, and (ii) $13.20 per share. At any other time upon the election of the Majority Holders or a Significant Holder, the outstanding principal amount of the 2020 Notes and any unpaid accrued interest will convert in whole into our Series G-1 preferred stock at the Series G-1 conversion price of $13.20 per share. If there is an event of default prior to selection of such option, the 2020 Notes will be converted at a conversion price equal to the Series G-1 preferred stock conversion price of $13.20 per share multiplied by 75%. Upon any event of default, the Majority Holders can, by providing us with a written notice, declare the principal and unpaid accrued interest under the 2020 Notes immediately due and payable. The 2020 Notes include embedded derivatives that are required to be bifurcated from the 2020 Notes and accounted for separately as a single, compound embedded derivative instrument under ASC 815, Derivatives (2020 Notes derivative liability). We determined that the share settled redemption in the case of a financing or an IPO discussed above represents an embedded derivative that is not clearly and closely related to the debt host and have accounted for these settlement alternatives as separate embedded derivative liability. The fair value of the 2020 derivative liability of $3.9 million was recorded on the issuance date of the 2020 Notes resulting in a debt discount, which is reported as a direct deduction from the face amount of the 2020 Notes. The 2020 derivative liability is remeasured to its fair value at the end of each reporting period and any change in fair value is recognized in other income (expense), net in the statements of operations and comprehensive loss. The fair value of the 2020 derivative liability upon the effectiveness of the IPO was recognized in the consolidated statements of operations and comprehensive loss and the derivative liability was extinguished. We incurred debt issuance costs of $0.1 million in connection with the 2020 Notes Agreement, which are reported on the balance sheet as a direct deduction from the face amount of the 2020 Notes. Debt discount of $4.0 million is being amortized using the effective interest rate method over the term of the note and recorded as a non-cash interest expense. During the year ended December 31, 2020, we recorded interest expense of $1.6 million on the 2020 Notes. Our obligations with respect to the 2020 Notes are unsecured and subordinated to our obligations with respect to the CIBC Loan. The 2020 Notes include customary events of default. Upon the closing of our IPO in October 2020, the 2020 Notes, including accrued interest thereon, automatically converted into 2,561,484 shares of our common stock at a conversion price of $13.20 per share. Credit Agreemen t In April 2020, Pulmonx International Sàrl, our wholly-owned subsidiary, entered into a COVID-19 Credit Agreement with UBS Switzerland AG to receive up to 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under Swiss Federal Government program to mitigate the economic impact of the spread of the coronavirus. In May 2020, Pulmonx International Sàrl received 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under the COVID-19 Credit Agreement. The COVID-19 Credit Agreement will bear no interest and is payable within 60 months after receipt of funds. As of December 31, 2020, Pulmonx International Sàrl did not make any repayment of credit agreement. Paycheck Protection Program On April 16, 2020, the Company received $2.7 million in support from the Paycheck Protection Program (the “PPP”) established by the U.S. federal government as part of the CARES Act for the PPP. Because the U.S. government subsequently changed its position and guidelines related to the PPP and publicly traded companies, the Company repaid the loan on May 1, 2020. 132 Table of Contents Funding Requirements We expect to incur continued expenditures in the future in support of our commercial infrastructure, sales force and other commercialization efforts. In addition, we intend to continue to make investments in the development of our products, including ongoing research and development programs. We also expect to incur additional costs associated with operating as a public company. Lastly, we may also undertake additional expenses to further expand our commercial organization and efforts, enhance our research and development efforts and pursue product expansion opportunities. As of December 31, 2020, we had cash and cash equivalents of $231.6 million. Based on our current planned operations, we expect that our cash and cash equivalents will enable us to fund our operating expenses for at least 12 months from the issuance of our financial statements as of and for the year ended December 31, 2020. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect. Because of the numerous risks and uncertainties associated with research, development and commercialization of medical devices, we are unable to estimate the exact amount of our working capital requirements. Our future funding requirements will depend on many factors, including: • the costs of commercialization activities related to commercializing our products in the United States and elsewhere, including expanding territories, increasing sales and marketing personnel, actual and anticipated product sales, marketing programs, manufacturing and distribution costs; • the impact of the COVID-19 pandemic on our business; • the cost of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights; • the research and development activities we intend to undertake, product enhancements that we intend to pursue; • whether or not we pursue acquisitions or investments in businesses, products or technologies that are complementary to our current business; • the degree and rate of market acceptance of our products in the United States and elsewhere; • changes or fluctuations in our inventory supply needs and forecasts of our supply needs; • our need to implement additional infrastructure and internal systems; • our ability to hire additional personnel to support our operations as a public company; and • the emergence of competing technologies or other adverse market developments. Until such time, if ever, as we can generate product revenue sufficient to achieve profitability, we expect to finance our cash needs through a combination of public or private equity offerings, debt financings and collaborations or licensing arrangements. There can be no assurance that our efforts to procure additional financing will be successful or that, if they are successful, the terms and conditions of such financing will be favorable to us or our stockholders. If we do raise additional capital through public or private equity or convertible debt offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional capital through collaborations agreements, licensing arrangements or marketing and distribution arrangements, we may have to relinquish valuable 133 Table of Contents rights to our technologies, future revenue streams, research programs or product candidates or grant licenses that may not be favorable to us. If we are unable to raise capital when needed, we will need to delay, limit, reduce or terminate planned commercialization or product development activities, or grant rights to develop and commercialize products or product candidates that we would otherwise prefer to develop and market ourselves in order to reduce costs. Summary Statement of Cash Flows The following table sets forth the primary sources and uses of cash and cash equivalents for the period presented below: Years Ended December 31, 2020 2019 2018 (in thousands) (in thousands) Net cash (used in) provided by: Operating activities $ (30,633) $ (20,765) $ (18,394) Investing activities 12,694 (14,233) 200 Financing activities 234,831 45,619 12,114 Effect of exchange rate changes on cash and cash equivalents 133 22 154 Net increase (decrease) in cash, cash equivalents and restricted cash $ 217,025 $ 10,643 $ (5,926) Cash Flows from Operating Activities Net cash used in operating activities was $30.6 million for the year ended December 31, 2020. Cash used in operating activities was primarily a result of the net loss of $32.2 million, an increase in inventory of $5.0 million primarily due to higher inventory levels required to support projected increase in sales, an increase in prepaid and other current assets of $1.8 million, a decrease in income taxes payable of $0.2 million, a decrease in lease liabilities of $0.9 million, and a non-cash credit resulting from the change in the fair value of derivative liabilities of $3.2 million due to extinguishment of derivative liability upon IPO partially offset by a decrease in accounts receivable of $1.5 million, an increase in accrued liabilities of $1.0 million, an increase in accounts payable of $0.6 million, stock based compensation expense of $3.2 million, write-down of inventory due to obsolescence of $0.5 million, depreciation and amortization expense of $0.5 million, amortization of debt discount and debt issuance costs of $1.0 million, non-cash lease expense of $1.5 million and non-cash charges for write-off of deferred offering costs of $3.0 million as we withdrew our registration statement for our initial public offering in May 2020. The increase in prepaid expenses, accrued liabilities and accounts payable is primarily due to increases in inventory and expenses related to operating as a public company and timing of payments to our vendors. Net cash used in operating activities was $20.8 million for the year ended December 31, 2019. Cash used in operating activities was primarily a result of the net loss of $20.7 million, an increase in accounts receivable of $2.5 million primarily due an increase in sales, an increase in inventory of $2.6 million primarily due to higher inventory levels required to support higher sales and projected increase in sales and an increase in prepaid and other current assets of $0.7 million partially offset by, an increase in accrued liabilities of $3.4 million, an increase in accounts payable of $0.5 million, a change in the fair value of the derivative liability of $0.5 million, depreciation and amortization expense of $0.4 million, stock-based compensation expense of $0.4 million and a write down of inventory due to obsolescence of $0.3 million. The increases in prepaid expenses and other current assets, accrued liabilities and accounts payable is primarily due to increases in inventory, an increase in manufacturing, selling, general and administrative expenses and timing of payments to our vendors. Net cash used in operating activities was $18.4 million for the year ended December 31, 2018. Cash used in operating activities was primarily a result of the net loss of $18.5 million, an increase in accounts receivable of $0.3 million due to an increase in sales, an increase in inventory of $1.2 million to support projected increases in sales, a 134 Table of Contents decrease in accounts payable of $0.6 million due to timing of payments to vendors, a decrease in deferred tax liability of $0.2 million, a decrease of $0.1 million in deferred rent liability partially offset by, an increase in accrued liabilities of $0.9 million due to timing of payments to vendors, change in the fair value of the derivative liability of $0.6 million, depreciation and amortization expense of $0.3 million, stock-based compensation expense of $0.4 million and write down of inventory due to obsolescence of $0.3 million. Cash Flows from Investing Activities Net cash provided by investing activities for the year ended December 31, 2020 was $12.7 million primarily consisting of maturities of short-term investments of $13.6 million offset by purchased of property and equipment of $0.9 million. Net cash used in investing activities in the year ended December 31, 2019 was $14.2 million primarily consisting of purchases of short-term marketable securities of $21.5 million and purchases of property and equipment of $0.7 million offset by maturities of investments of $7.9 million. Net cash provided by investing activities in the year ended December 31, 2018 was $0.2 million primarily consisting of maturities of investments of $0.5 million, offset by the purchases of property and equipment of $0.3 million. Cash Flows from Financing Activities Net cash provided by financing activities in the year ended December 31, 2020 of $234.8 million primarily relates to net proceeds from our initial public offering of $201.4 million, proceeds of $17.3 million from borrowing under the CIBC Agreement and COVID-19 Credit Agreement, net of lender fees and costs, proceeds of $33.0 million from the issuance of 2020 Notes, net of lender fees and costs, proceeds of $2.3 million from the exercise of warrants for Series C-1 preferred stock, and $2.7 million proceeds from the exercise of stock options, partially offset by repayment of debt obligations of $17.2 million under the Oxford Agreement, payment of Success Fee of $1.9 million, payment of deferred offering costs of $2.5 million and payment of debt issuance cost of $0.2 million. Net cash provided by financing activities in the year ended December 31, 2019 of $45.6 million primarily relates to proceeds of $6.0 million from the issuance of the convertible note to BSC, proceeds of $39.7 million from issuance of Series G-1 preferred stock, net of issuance costs and $0.5 million proceeds from the exercise of stock options offset by payment of deferred offering costs of $0.6 million. Net cash provided by financing activities in the year ended December 31, 2018 of $12.1 million primarily relates to proceeds of $12.0 million from additional borrowings under the BSC Agreement and proceeds of $0.1 million from the exercise of stock options and preferred stock warrants. Contractual Obligations and Commitments The following table summarizes our contractual obligations as of December 31, 2020: Payments Due by Period (in thousands) Less than 1 year 1-3 years 3-5 years More than 5 years Total Lease obligations (1) $ 2,769 $ 7,453 $ 1,007 $ — $ 11,229 Long-term debt obligations (2) 723 17,146 564 — 18,433 $ 3,492 $ 24,599 $ 1,571 $ — $ 29,662 _______________ (1) We lease our laboratory and office facilities in Redwood City, California, which expires in July 2025, and Neuchâtel, Switzerland, which can be cancelled with 12 months notice. In April 2020, we executed a sublease for another office facility in Redwood City, California for a three-year term commencing on June 1, 2020. The lease agreement provides for early termination if the Company or Sublandlord elects to terminate the lease, which may only occur on or after the expiration of the 18th full calendar month of the sublease term. The lease term for this lease is 18 months as it is not reasonably certain that we will not exercise early termination option. In September 2020, we amended a 135 Table of Contents sublease agreement entered in April 2020, to include additional facility space in Redwood City, California for a four-year term. The sublease agreement can be extended for an additional twelve month period, at our option. The lease term for this lease is 4 years as it is not reasonably certain that we will exercise the renewal option. The amendment also changed the lease term of sublease agreement entered in April 2020, which was extended until May 31, 2024, but left the early termination clause unchanged. (2) In February 2020, we received $17.0 million gross proceeds from the CIBC Loan. In April 2020, we received $33.0 million in gross proceeds from the issuance of the 2020 Notes. We have the option to draw up to an additional $33.0 million of 2020 Notes, provided that any such draw be for no less than $5.0 million on or prior to April 17, 2022. Upon the closing of our IPO in October 2020, the 2020 Notes, including accrued interest thereon, automatically converted into 2,561,484 shares of our common stock at a conversion price of $13.20 per share. In May 2020, Pulmonx International Sàrl, our wholly-owned subsidiary, received 0.5 million Swiss Francs ($0.5 million U.S. dollar equivalent) under the COVID-19 Credit Agreement. The COVID-19 Credit Agreement bears no interest and is payable within 60 months after receipt of funds. We enter into contracts in the normal course of business with third-party contract organizations for pre-clinical studies and testing, manufacture and supply of our pre-clinical materials and providing other services and products for operating purposes. These contracts generally provide for termination following a certain period after notice, and therefore we believe that our non-cancelable obligations under these agreements are not material. Critical Accounting Policies, Significant Judgments and Use of Estimates Our financial statements have been prepared in accordance with GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses incurred during the reporting periods. Our estimates are based on our knowledge of current events and actions we may undertake in the future and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may materially differ from these estimates under different assumptions or conditions. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management’s judgments and estimates. For more detail on our critical accounting policies, refer to Note 2 to the financial statements appearing elsewhere in this Annual Report on Form 10-K. Revenue Recognition Our revenue is generated from the sale of our products to distributors and hospitals in the U.S. and international markets. Revenue is measured as the amount of consideration we expect to receive in exchange for transferring the products. Revenue is recognized when obligations under the terms of a contract with customers are satisfied, which occurs with the transfer of control of our products to our customers, either upon shipment of the product or delivery of the products to the customer under the terms and conditions agreed with the customer. We defer revenue relating to any remaining performance obligations by us to the customer after delivery, such as free products and free analysis services of patient scans to determine suitability of the patients for the treatment using the Zephyr Valves. We identify performance obligations in contracts with customers, which may include our products and implied promises to provide free products and analysis services for patient scans. The transaction price is determined based on the amount expected to be entitled to in exchange for transferring the promised services or product to the customer. We are entitled to the total consideration for the products ordered by customers, net of early pay discounts, volume-based rebates and other transaction price adjustments. We exclude taxes assessed by governmental authorities on revenue-producing transactions from the measurement of the transaction price. We accept product returns at our discretion or if the product is defective as manufactured. We elected to treat shipping and handling costs as a fulfillment cost and include them in the cost of goods sold as incurred. Inventories Inventories are valued at the lower of cost to purchase or manufacture the inventory or net realizable value. Cost is determined using the first-in, first-out method for all inventories. Net realizable value is determined as the estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal and transportation. We record write-downs of inventories which are obsolete or in excess of anticipated demand or 136 Table of Contents market value based on consideration of product lifecycle stage, technology trends, product development plans and assumptions about future demand and market conditions. Inventory write-downs are intended to reduce the carrying value of inventory to its net realizable value. Research and Development Research and development expenses consist of costs incurred to further our research and development activities and include compensation costs, stock-based compensation, engineering and research expenses, clinical trials and related expenses, regulatory expenses, manufacturing expenses incurred to build products for testing, allocated facilities costs, consulting fees and other expenses incurred to sustain our overall research and development programs. All research and development costs are expensed as incurred. Clinical trial costs are a significant component of our research and development expenses. We have a history of contracting with third parties that perform various clinical trial activities on our behalf in the ongoing development of our product candidates. The financial terms of these contracts are subject to negotiations and may vary from contract to contract and may result in uneven payment flow. We accrue and expense costs of our clinical trial activities performed by third parties, including CROs and other service providers, based upon estimates of the work completed over the life of the individual study in accordance with associated agreements. We determine these estimates through discussion with internal personnel and outside service providers as to progress or stage of completion of trials or services pursuant to contracts with clinical research organizations and other service providers and the agreed-upon fee to be paid for such services. Preferred Stock We record all shares of preferred stock at their respective fair values on the dates of issuance, net of issuance costs. Our preferred stock is recorded outside of permanent equity because while it is not mandatorily redeemable, in certain events considered not solely within our control, such as a merger, acquisition or sale of all or substantially all of our assets, each of which we refer to as a deemed liquidation event, our preferred stock will become redeemable at the option of the holders of at least a majority of the then outstanding such shares. We have not adjusted the carrying values of the preferred stock to its liquidation preference because a deemed liquidation event obligating us to pay the liquidation preferences to holders of shares of preferred stock is not probable. Subsequent adjustments to the carrying values to the liquidation preferences will be made only when it becomes probable that such a deemed liquidation event will occur. Preferred Stock Warrants We have issued freestanding warrants to purchase shares of preferred stock. We accounted for these warrants as a liability in our financial statements because the underlying instrument into which the warrants are exercisable contains deemed liquidation provisions that are outside our control. The warrants were recorded at fair value using an option pricing model based on an allocation of our aggregate value to the outstanding equity instruments, applying a discount to the warrant value for lack of marketability. The warrants were subject to remeasurement at each balance sheet date with any changes in fair value being recognized as a component of other income (expense), net in the statements of operations and comprehensive loss. We continued to adjust the liability for changes in fair value until the exercise or expiration of the preferred stock warrants in February 2020 (see Note 9 to our consolidated financial statements) at which time the related final fair value of the warrant liability was reclassified to stockholders’ equity (deficit). Derivative Instruments In connection with the Oxford Agreement, we entered into the Success Fee Agreement. In the event of a sale or other disposition by the Company of all or substantially all of its assets, a merger or consolidation, or an initial public offering (a Liquidity Event), before the termination of the agreement on August 28, 2021, we are required to pay up to $2.5 million to Oxford Finance LLC. The Success Fee is equal to 6.25% of the term loan if the Liquidity Event occurs within 18 months of August 28, 2014, 8.75% if the Liquidity Event occurs after 18 months and within 137 Table of Contents 3 years of August 28, 2014, and 12.50% if the Liquidity Event occurs after the third anniversary of August 28, 2014. As of December 31, 2019, the maximum amount of Success Fee subject to a potential payout was $1.9 million. This agreement has been identified as a freestanding derivative under ASC 815, Derivatives (“Success Fee”) and is remeasured to its fair value at the end of each reporting period and any change in fair value is recognized as change in other income (expense), net in the statements of operations and comprehensive loss (see Note 4 to our consolidated financial statements). We valued the Success Fee derivative liability based on the Success Fee amount of $1.9 million and the probability and estimated timing of a Liquidity Event. On October 5, 2020, in connection with the IPO, we paid $1.9 million pursuant to the Success Fee Agreement to Oxford Finance LLC. The 2020 Notes include embedded derivatives that are required to be bifurcated from the 2020 Notes and accounted for separately as a single, compound embedded derivative instrument under ASC 815, Derivatives (2020 Notes derivative liability). We determined that the share settled redemption in the case of a financing or an IPO represents an embedded derivative that is not clearly and closely related to the debt host and have accounted for these settlement alternatives as separate embedded derivative liability. The fair value of the 2020 derivative liability of $3.9 million was recorded on the issuance date of the 2020 Notes resulting in a debt discount, which is reported as a direct deduction from the face amount of the 2020 Notes. The 2020 derivative liability is remeasured to its fair value at the end of each reporting period and any change in fair value is recognized in other income (expense), net in the statements of operations and comprehensive loss. We valued the 2020 Notes derivative liability using the “with and without” methodology. The “with and without” methodology involves valuing the convertible note on an as is basis and then valuing the 2020 Notes without each individual embedded derivative. The difference between the value of the 2020 Notes with the embedded derivatives and the value without each individual embedded derivative equals the fair value of that embedded derivative. We used a Monte Carlo Simulation (“MCS”) to value the embedded derivatives. The first step of each simulation was to forecast our Series G-1 preferred stock price through the expiration of the 2020 Notes. In order to estimate the future share price of the Series G-1 preferred stock, we applied a “random walk” model based upon a Geometric Brownian Motion process with a constant drift. The fair value of the 2020 Notes derivative liability was determined using the following assumptions: April 17 2020 Risk-free interest rate 0.2 % Current Series G-1 convertible preferred stock value per share $ 0.84 Series G-1 convertible preferred stock volatility 34.4 % Upon the closing of the IPO in October 2020, the 2020 Notes converted pursuant to a qualified initial public offering. As a result, we concluded that the 2020 Notes derivative had no value upon the closing of the IPO, because value of the notes with and without such derivative was the same. Common Stock Valuation and Stock-Based Compensation We recognize compensation costs related to stock options granted to employees and non-employees based on the estimated fair value of the awards on the date of grant. We estimate the grant date fair value, and the resulting stock-based compensation expense, using the Black-Scholes option pricing model. The grant date fair value of stock-based awards is expensed on a straight-line basis over the period during which the optionee is required to provide service in exchange for the award, which is typically the vesting period. We account for forfeitures as they occur. Estimates of the fair value of equity awards as of the grant date using valuation models such as the Black-Scholes option pricing model are affected by assumptions with a number of complex variables. Changes in the assumptions can materially affect the fair value and ultimately the amount of stock-based compensation expense recognized. 138 Table of Contents These inputs are subjective and generally require significant analysis and judgment to develop. Changes in the following assumptions can materially affect the estimate of the fair value of stock-based compensation: • Expected Term. The expected term is calculated using the simplified method, which is available where there is insufficient historical data about exercise patterns and post-vesting employment termination behavior. The simplified method is based on the vesting period and the contractual term for each grant, or for each vesting-tranche for awards with graded vesting. The mid-point between the vesting date and the maximum contractual expiration date is used as the expected term under this method. For awards with multiple vesting-tranches, the periods from grant until the mid-point for each of the tranches are averaged to provide an overall expected term. • Expected Volatility. The expected volatility is derived from the average historical volatilities of publicly traded companies within our industry that we consider to be comparable to our business over a period approximately equal to the expected term for the options. In evaluating similarity, we considered factors such as stage of development, risk profile, enterprise value and position within the life sciences industry. • Risk-free Interest Rate. The risk-free interest rate is based on the U.S. Treasury yield in effect at the time of the grant for zero-coupon U.S. Treasury notes with remaining terms similar to the expected term of the options. • Dividend Rate. We assumed the expected dividend to be zero as we have never paid dividends and have no current plans to do so. Common Stock Valuation Prior to the Company’s IPO, the estimated fair value of the common stock underlying our stock options and stock awards was determined at each grant date by our board of directors, with input from management. All options to purchase shares of our common stock are intended to be exercisable at a price per share not less than the per-share fair value of our common stock underlying those options on the date of grant. In the absence of a public trading market for our common stock, on each grant date, we develop an estimate of the fair value of our common stock based on the information known to us on the date of grant, upon a review of any recent events and their potential impact on the estimated fair value per share of the common stock, and in part on contemporaneous input from an independent third-party valuation firm. Our valuations of our common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation (Practice Aid). The assumptions used to determine the estimated fair value of our common stock are based on numerous objective and subjective factors, combined with management judgment, including: • external market conditions affecting the pharmaceutical and medical devices industry and trends within the industry; • our stage of development and business strategy; • the rights, preferences and privileges of our convertible preferred stock relative to those of our common stock; • the prices at which we sold shares of our convertible preferred stock; • our financial condition and operating results, including our levels of available capital resources; 139 Table of Contents • the progress of our research and development efforts; • equity market conditions affecting comparable public companies; and • general U.S. market conditions and the lack of marketability of our common stock. For our valuations performed in August 2019, we applied the market approach outlined in the Practice Aid to determine our enterprise value. Specifically, we used the guideline public company analysis, which relies on an analysis of publicly traded companies similar in industry or business model to us and uses these guideline companies to develop relevant market multiples and ratios. These multiples and ratios were then applied to our corresponding financial metrics. For our valuations performed in November 2019 and April 2020, we applied a weighted combination of the market approach and the income approach outlined in the Practice Aid to determine our enterprise value. Under the market approach, we used the guideline public company analysis, guideline transactions analysis and an analysis based on a recent acquisition offer. For the guideline public company and guideline transactions analysis, we identified a group of comparable public companies and recent transactions within our industry. For the comparable companies, we estimated market multiples and ratios. These multiples and ratios were then applied to our corresponding financial metrics. When selecting comparable companies, consideration was given to industry similarity, their specific products offered, financial data availability and capital structure. The income approach incorporates the use of a discounted cash flow model in which our estimated future cash flows and our residual value beyond the forecast period are discounted using an appropriately risk-adjusted weighted average cost of capital. Our forecasts used in the discounted cash flow model are based in part on strategic plans and represent our estimates based on current and forecasted business and market conditions. The Practice Aid identifies various available methods for allocating enterprise value across classes and series of capital stock to determine the estimated fair value of common stock at each valuation date. In accordance with the Practice Aid, we considered the following methods: • Option Pricing Method. Under the option pricing method (OPM), shares are valued by creating a series of call options with exercise prices based on the liquidation preferences and conversion terms of each equity class. The estimated fair values of the preferred and common stock are inferred by analyzing these options. • Probability-Weighted Expected Return Method. The probability-weighted expected return method is a scenario-based analysis that estimates value per share based on the probability-weighted present value of expected future investment returns, considering each of the possible outcomes available to us, as well as the economic and control rights of each share class. We determined that the OPM method was the most appropriate method for allocating our enterprise value to determine the estimated fair value of our common stock. In determining the estimated fair value of our common stock, our board of directors also considered the fact that our stockholders could not freely trade our common stock in the public markets. Accordingly, we applied discounts to reflect the lack of marketability of our common stock based on the weighted-average expected time to liquidity. The estimated fair value of our common stock at each grant date reflected a non-marketability discount partially based on the anticipated likelihood and timing of a future liquidity event. As of December 31, 2020, there was $14.8 million of unrecognized compensation costs related to non-vested common stock options, expected to be recognized over a weighted-average period of 2.28 years. Subsequent to December 31, 2020, we granted options for 8,600 shares of common stock and 6,300 restricted stock units to employees, subject to service-based vesting conditions, which vest over a weighted-average period of 4 years. The options have a weighted-average exercise price of $62.34 per share. Subsequent to the Company’s IPO, the fair value of the Company’s common stock is determined based on its closing market price. 140 Table of Contents Income Taxes Our major tax jurisdictions are the United States and California, Switzerland and Neuchâtel, and Grand Cayman. We provide for income taxes under the asset and liability method. Current income tax expense or benefit represents the amount of income taxes expected to be payable or refundable for the current year. Deferred income tax assets and liabilities arise due to differences between when assets or liabilities are recognized for tax purposes and when they are recognized for financial reporting purposes. Net operating losses and credit carryforwards are also deferred tax assets. Deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when such items are expected to reverse. Deferred income tax assets are reduced, as necessary, by a valuation allowance when management determines it is more likely than not that some or all of the tax benefits will not be realized. We assess all material positions taken in any income tax return, including all significant uncertain positions, in all tax years that are still subject to assessment or challenge by relevant taxing authorities. All of our tax years will remain open for examination by the federal and state tax authorities for three and four years, respectively, from the date of utilization of the net operating loss or research and development credits. We do not have any tax audits or other issues pending. Utilization of the net operating loss carryforwards and research and development tax credit carryforwards may be subject to annual limitations due to the ownership change limitations provided by the Internal Revenue Code of 1986, as amended (Code), as defined in Section 382, and other similar state provisions. The annual limitation may result in the expiration of net operating losses and credits before utilization. The 2017 Tax Cut and Jobs Act included the implementation of a modified territorial tax system, which has the effect of subjecting earnings of our foreign subsidiaries to U.S. taxation on Global Intangible Low-Taxed Income (GILTI). The FASB allows companies to adopt a policy election to account for the tax on GILTI under one of two methods: (i) account for the tax on GILTI as a component of tax expense in the period in which the tax is incurred (the period cost method) or (ii) account for the tax on GILTI in a company’s measurement of deferred taxes (the deferred method). We have elected to account for the tax on GILTI under the period cost method. The Coronavirus Aid, Relief, and Economic Security (“CARES”) Act enacted in March 2020 did not provide an income tax benefit for us given our historical U.S. losses and a full valuation allowance against our net U.S. deferred tax assets. JOBS Act Accounting Election The Jumpstart Our Business Startups Act of 2012 (JOBS Act) permits an “emerging growth company” such as us to take advantage of an extended transition period to comply with new or revised accounting standards applicable to public companies. However, we have chosen to irrevocably “opt out” of such extended transition period, and as a result, we will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-emerging growth companies. Recent Accounting Pronouncements See “Recent Accounting Pronouncements” in Note 3 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K for additional information.