TransMedics Group, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Annual Report on Form 10-K. Some of the information contained in this discussion and analysis or set forth elsewhere in this Annual Report on Form 10-K, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the “Item 1A. Risk Factors” section of this Annual Report on Form 10-K, our actual results could differ materially from the results described in or implied by the forward-looking statements contained in the following discussion and analysis. Overview We are a commercial-stage medical technology company transforming organ transplant therapy for end-stage organ failure patients across multiple disease states. We developed the OCS to replace a decades-old standard of care that we believe is significantly limiting access to life-saving transplant therapy for hundreds of thousands of patients worldwide. Our innovative OCS technology replicates many aspects of the organ’s natural living and functioning environment outside of the human body. As such, the OCS represents a paradigm shift that transforms organ preservation for transplantation from a static state to a dynamic environment that enables new capabilities, including organ optimization and assessment. We believe the use of the OCS has the potential to significantly increase the number of organ transplants and improve post-transplant outcomes. We have developed our National OCS Program, a turnkey solution to provide outsourced organ retrieval and OCS organ management, to provide transplant programs with a more efficient process to procure donor organs with the OCS. We designed the OCS to be a platform that allows us to leverage core technologies across products for multiple organs. To date, we have developed three OCS products, one for each of lung, heart and liver transplantations, making the OCS the only multi-organ technology platform. We have commercialized the OCS Lung and OCS Heart outside of the United States. By the end of the third quarter of 2021, all three of our products, OCS Lung, OCS Heart, and OCS Liver have received Pre-Market Approval, or PMA, from the Food and Drug Administration, or FDA, as follows: • OCS Lung for the preservation of standard criteria donor lungs for double-lung transplantation; • OCS Lung for the preservation of donor lungs initially deemed unsuitable due to limitations of cold storage for double-lung transplantation; • OCS Heart for the preservation of DBD donor hearts deemed unsuitable due to limitations of cold storage (e.g. >4 hours of cross-clamp time); and • OCS Liver for the preservation of DBD and DCD donor livers < 55 years old, macrosteatosis <15% and with < 30 mins of warm ischemia time. Since our inception, we have focused substantially all of our resources on designing, developing and building our proprietary OCS technology platform and organ-specific OCS products; obtaining clinical evidence for the safety and effectiveness of our OCS products through clinical trials; securing regulatory approval; organizing and staffing our company; planning our business; raising capital; commercializing our products; developing our market and distribution chain and providing general and administrative support for these operations. To date, we have funded our operations primarily with proceeds from sales of preferred stock, borrowings under loan agreements, proceeds from the sale of common stock in our public offerings and revenue from clinical trials and commercial sales of our OCS products. Since our inception, we have incurred significant operating losses. Our ability to generate net revenue sufficient to achieve profitability will depend on the successful further development and commercialization of our products. We generated net revenue of $30.3 million and $25.6 million for the years ended December 31, 2021 and 2020, respectively. We incurred net losses of $44.2 million and $28.7 million, respectively, for those same years. As of December 31, 2021, we had an accumulated deficit of $442.4 million. We expect to continue to incur net losses for the foreseeable future as we focus on growing commercial sales of our products in both the United States and select non-U.S. markets, including growing our commercial team, which will pursue increasing commercial sales of our OCS products; scaling our manufacturing operations; building our commercial operations, continuing research, development and clinical trial efforts; seeking regulatory clearance for new products and product enhancements, including new indications, in both the United States and select non-U.S. markets; and operating as a public company. As a result, we will need substantial additional funding for expenses related to our operating activities, including selling, general and administrative expenses and research, development and clinical trials expenses. 62 Because of the numerous risks and uncertainties associated with product development and commercialization, we are unable to accurately predict the timing or amount of increased expenses or when, or if, we will be able to achieve or maintain profitability. Until such time, if ever, as we can generate substantial net revenue sufficient to achieve profitability, we expect to finance our operations through a combination of equity offerings, debt financings and strategic alliances. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms or at all. If we are unable to raise capital or enter into such agreements as, and when, needed, we may have to significantly delay, scale back or discontinue the further development and commercialization efforts of one or more of our products, or may be forced to reduce or terminate our operations. We believe that our cash, cash equivalents and marketable securities, will be sufficient for us to fund our operating expenses, capital expenditure requirements and debt service payments for at least 12 months following the filing of our Annual Report on Form 10-K. We have based this estimate on assumptions that may prove to be wrong, and we could exhaust our available capital resources sooner than we expect. See “—Liquidity and Capital Resources”. COVID-19 The COVID-19 pandemic, including efforts to contain the spread of the coronavirus, has impacted, and may continue to impact, our business, financial condition, operating results and cash flows, including as a result of the impact of new variants. Impacts to our business as a result of COVID-19 have included the temporary disruption of transplant procedures at many of the organ transplant centers who purchase OCS products; customer delays or reductions in customer capital expenditures and operating budgets and the related impact on our product sales; disruptions to our manufacturing operations and supply chain caused by facility closures, reductions in operating hours, staggered shifts and other social distancing efforts; labor shortages; decreased productivity and unavailability of materials or components; delays of reviews and approvals by the FDA and other health authorities; delays in our clinical trial enrollment; limitations on our employees’ and customers’ ability to travel, and delays in product installations, trainings or shipments to and from other affected countries and within the United States. In response to the pandemic, healthcare providers have, and may need to further, reallocate resources, such as physicians, staff, hospital beds and intensive care unit facilities, as they prioritize limited resources and personnel capacity to focus on the treatment of patients with COVID-19. These actions significantly delay the provision of other medical care such as organ transplantation and reduce the number of transplant procedures that are performed, which negatively impacts our revenue and cash flows. These measures and challenges may continue for the duration of the COVID-19 pandemic. The COVID-19 pandemic has also impacted, and may continue to impact, our third party suppliers, including through the effects of facility closures, reductions in operating hours, staggered shifts and other social distancing efforts, labor shortages, decreased productivity and unavailability of materials or components. While we maintain an inventory of finished products and raw materials used in our OCS products, a further prolonged pandemic could lead to shortages in the raw materials necessary to manufacture our products. The extent to which COVID-19 impacts operations of our third-party partners will depend on future developments, which are highly uncertain and cannot be predicted with confidence. If we experience a prolonged disruption in our manufacturing, supply chains, or commercial operations, we would expect to experience a material adverse impact on our business, financial condition, results of operations and prospects. Components of Our Results of Operations Net Revenue We generate revenue primarily from sales of our single-use, organ-specific disposable sets (i.e., our organ-specific OCS Perfusion Sets sold together with our organ-specific OCS Solutions) used on our organ-specific OCS Consoles, each being a component of our OCS products. To a lesser extent, we also generate revenue from the sale of OCS Consoles to customers and from the implied rental of OCS Consoles loaned to customers at no charge. For each new transplant procedure, customers purchase an additional OCS disposable set for use on the customer’s existing organ-specific OCS Console. All of our revenue has been generated by sales to transplant centers and Organ Procurement Organizations in the United States, Europe and Asia-Pacific, or, in some cases, to distributors selling to transplant centers in select countries. Substantially all of our customer contracts have multiple-performance obligations that contain promises consisting of OCS Perfusion Sets and OCS Solutions. In some of those contracts, the promises also include an OCS Console, whether sold or loaned to the customer. 63 We have customer agreements under which we loan our OCS Consoles to the customer for the duration of the agreement. In such cases, we place an organ-specific OCS Console at the customer site for its use free of charge, and the customer separately purchases from us the OCS disposable sets used in each transplant procedure. When we loan the OCS Console to the customer, we retain title to the console at all times and do not require minimum purchase commitments from the customer related to any OCS products. In such cases, we invoice the customer for OCS disposable sets based on customer orders received for each new transplant procedure and the prices set forth in the customer agreement. Over time, we typically recover the cost of the loaned OCS Console through the customer’s continued purchasing and use of additional OCS disposable sets. For these reasons, we have determined that part of the selling price for the disposable set is an implied rental payment for use of the OCS Console. Because all promises of a customer contract are delivered and recognized as revenue at the same time and because revenue allocated to promises other than OCS disposable sets, such as implied rental income and service revenue, is insignificant, all performance obligations from customer contracts are classified as a single category of revenue in our consolidated statements of operations. Under some of our customer clinical trial agreements, we made payments to our customers for reimbursements of clinical trial materials and for specified clinical documentation related to their use of our OCS products. Because some of these payments did not provide us with a separately identifiable benefit, we recorded such payments as a reduction of revenue from the customer, resulting in our net revenue presentation. We recorded reimbursable clinical trial costs as a reduction of revenue of $1.1 million and $2.7 million for the years ended December 31, 2021 and 2020, respectively. Through December 31, 2021, all of our sales outside of the United States have been commercial sales (unrelated to any clinical trials). We expect that our net revenue will increase over the long term as a result of receiving PMAs for the OCS Lung, OCS Heart and OCS Liver in the United States. Additionally, commercial sales of OCS disposable sets generally have a higher average selling price than clinical trial sales of OCS disposable sets. We also expect that our net revenue will increase over the long term as a result of anticipated growth in non-U.S. sales if national healthcare systems begin to reimburse transplant centers for the use of the OCS, if transplant centers utilize the OCS in more transplant cases and if more transplant centers adopt the OCS in their programs. Cost of Revenue, Gross Profit and Gross Margin Cost of revenue consists primarily of costs of components of our OCS Consoles and disposable sets, costs of direct materials, labor and the manufacturing overhead that directly supports production, and costs related to the depreciation of OCS Consoles loaned to customers. When we loan an OCS Console to a customer for its use free of charge, we capitalize as property and equipment the cost of our OCS Console and depreciate these assets over the five-year estimated useful life of the console. Included in the cost of OCS disposable sets are the costs of our OCS Lung, OCS Heart and OCS Liver Solutions. We expect that cost of revenue will increase or decrease in absolute dollars primarily as, and to the extent that, our net revenue increases or decreases. Gross profit is the amount by which our net revenue exceeds our cost of revenue in each reporting period. We calculate gross margin as gross profit divided by net revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily production volumes, the cost of components and direct materials, manufacturing overhead costs, direct labor, the selling price of our OCS products and fluctuations in amounts paid by us to customers related to reimbursements of their clinical trial expenses during clinical trials. We expect that cost of revenue as a percentage of net revenue will moderately decrease and gross margin and gross profit will moderately increase over the long term as our sales and production volumes increase and our cost per unit of our OCS disposable sets decreases due to economies of scale. We intend to use our design, engineering and manufacturing capabilities to further advance and improve the efficiency of our manufacturing processes, which we believe will reduce costs and increase our gross margin. While we expect gross margin to increase over the long term, it will likely fluctuate from quarter to quarter. 64 Operating Expenses Research, Development and Clinical Trials Expenses Research, development and clinical trials expenses consist primarily of costs incurred for our research activities, product development, hardware and software engineering, clinical trials to continue to develop clinical evidence of our products’ safety and effectiveness, regulatory expenses, testing, consultant services and other costs associated with our OCS technology platform and OCS products, which include: • employee-related expenses, including salaries, related benefits and stock-based compensation expense for employees engaged in research, hardware and software development, regulatory and clinical trial functions; • expenses incurred in connection with the clinical trials of our products, including under agreements with third parties, such as consultants, contractors and data management organizations; • the cost of maintaining and improving our product designs, including the testing of materials and parts used in our products; • laboratory supplies and research materials; and • facilities, depreciation and other expenses, which include direct and allocated expenses for rent and maintenance of facilities and insurance. We expense research, development and clinical trials costs as incurred. In the future, we expect that research, development and clinical trials expenses will increase over the long term due to ongoing product development and approval efforts. We expect to continue to perform activities related to obtaining additional regulatory approvals for expanded indications in the United States and other served geographies, as well as developing the next generation of our OCS technology platform. Selling, General and Administrative Expenses Selling, general and administrative expenses consist primarily of salaries and related costs, including stock-based compensation, for personnel in our commercial team and personnel in executive, marketing, finance and administrative functions. Selling, general and administrative expenses also include direct and allocated facility-related costs, promotional activities, marketing, conferences and trade show costs as well as professional fees for legal, patent, consulting, investor and public relations, accounting and audit services. We expect to continue to increase headcount in our commercial team and increase marketing efforts as we continue to grow commercial sales of our OCS products in both U.S. and select non-U.S. markets. We expect that our selling, general and administrative expenses will increase over the long term as we increase our headcount to support the expected continued sales growth of our OCS products. We also anticipate that we will continue to incur increased accounting, audit, legal, regulatory, compliance and director and officer insurance costs as well as investor and public relations expenses associated with our continued operation as a public company. Other Income (Expense) Interest Expense Interest expense consists of interest expense associated with outstanding borrowings under our loan agreement as well as the amortization of debt discount associated with such agreement. 65 Other Income (Expense), Net Other income (expense), net includes interest income, realized and unrealized foreign currency transaction gains and losses and other non-operating income and expense items unrelated to our core operations. Interest income consists of interest earned on our invested cash balances. Foreign currency transaction gains and losses result from intercompany transactions as well as transactions with customers or vendors denominated in currencies other than the functional currency of the legal entity in which the transaction is recorded. Provision for Income Taxes Since our inception, we have not recorded any U.S. federal or state income tax benefits for the net operating losses we have incurred in each year or for the research and development tax credits we generated in the United States, as we believe, based upon the weight of available evidence, that it is more likely than not that all of our net operating loss carryforwards and tax credits will not be realized. We record provisions for foreign income taxes of an insignificant amount related to the operations of one of our foreign subsidiaries. As of December 31, 2021, we had U.S. federal and state net operating loss carryforwards of $368.1 million and $304.0 million, respectively, which may be available to offset future taxable income and begin to expire in 2022 and 2030, respectively. Our federal net operating loss carryforwards include $156.4 million that can be carried forward indefinitely. As of December 31, 2021, we also had U.S. federal and state research and development tax credit carryforwards of $8.0 million and $5.3 million, respectively, which may be available to offset future tax liabilities and begin to expire in 2022 and 2024, respectively. As of December 31, 2021, we had no foreign net operating loss carryforwards. We have recorded a full valuation allowance against our net deferred tax assets at each balance sheet date. Comparison of the Years Ended December 31, 2021 and 2020 The following table summarizes our results of operations for the years ended December 31, 2021 and 2020: Year Ended December 31, 2021 2020 Change (in thousands) Net revenue $ 30,262 $ 25,639 $ 4,623 Cost of revenue 9,103 9,004 99 Gross profit 21,159 16,635 4,524 Operating expenses: Research, development and clinical trials 22,304 18,831 3,473 Selling, general and administrative 38,283 24,188 14,095 Total operating expenses 60,587 43,019 17,568 Loss from operations (39,428 ) (26,384 ) (13,044 ) Other income (expense): Interest expense (3,874 ) (3,985 ) 111 Other income (expense), net (877 ) 1,653 (2,530 ) Total other expense, net (4,751 ) (2,332 ) (2,419 ) Loss before income taxes (44,179 ) (28,716 ) (15,463 ) Provision for income taxes (36 ) (32 ) (4 ) Net loss $ (44,215 ) $ (28,748 ) $ (15,467 ) 66 Net Revenue Year Ended December 31, 2021 2020 Change (in thousands) Net revenue by geography: United States $ 21,861 $ 19,239 $ 2,622 Outside the U.S. 8,401 6,400 2,001 Total net revenue $ 30,262 $ 25,639 $ 4,623 Net revenue by OCS product: OCS Lung net revenue $ 10,665 $ 6,194 $ 4,471 OCS Heart net revenue 17,683 14,196 3,487 OCS Liver net revenue 1,914 5,249 (3,335 ) Total net revenue $ 30,262 $ 25,639 $ 4,623 Net revenue from customers in the United States was $21.9 million in the year ended December 31, 2021 and increased by $2.6 million in the year ended December 31, 2021 compared to the year ended December 31, 2020 primarily due to higher sales volumes of our OCS Lung and OCS Heart disposable sets, partially offset by lower sales volumes of our OCS Liver disposable sets . Net revenue from sales of OCS Lung disposable sets in the United States increased from $5.4 million in the year ended December 31, 2020 to $9.8 million in the year ended December 31, 2021. The increase was due primarily to higher sales volume of OCS Lung disposable sets as the year ended December 31, 2020 was negatively impacted by the COVID-19 pandemic. Net revenue from OCS Heart disposable sets sold to customers commercially and for use in our ongoing clinical trials in the United States increased by $1.5 million during the year ended December 31, 2021. The increase was due to higher sales volume of OCS Heart disposable sets following approval from the FDA for commercial use in September 2021. Net revenue from OCS Liver disposable sets sold in the United States decreased by $3.3 million during the year ended December 31, 2021. The lower sales volume of OCS Liver disposable sets was primarily a result of the completion of enrollment in our OCS Liver PROTECT CAP Trial early in the first quarter of 2021. This decrease was partially offset by commercial sales of OCS Liver disposable sets sold following FDA approval in September 2021. Net revenue from customers outside the United States was $8.4 million in the year ended December 31, 2021 compared to $6.4 million in the year ended December 31, 2020. The increase in net revenue from customers outside the United States was primarily due to higher sales volume of OCS Heart disposable sets. Net revenue from OCS Heart disposable sets increased by $2.0 million from the year ended December 31, 2020 to the year ended December 31, 2021. Cost of Revenue, Gross Profit and Gross Margin Cost of revenue increased by $0.1 million in the year ended December 31, 2021 compared to the year ended December 31, 2020. Gross profit increased by $4.5 million in the year ended December 31, 2021 compared to the year ended December 31, 2020. Gross margin was 70% and 65% for the years ended December 31, 2021 and 2020, respectively. Gross profit and gross margin increased primarily as a result of increased sales volume and increased sales of higher margin OCS disposable sets. Operating Expenses Research, Development and Clinical Trials Expenses Year Ended December 31, 2021 2020 Change (in thousands) Personnel related (including stock-based compensation expense) $ 8,292 $ 7,853 $ 439 Clinical trials costs 3,180 4,708 (1,528 ) Consulting and third-party testing 4,212 1,432 2,780 Laboratory supplies and research materials 2,837 2,095 742 Other 3,783 2,743 1,040 Total research, development and clinical trials expenses $ 22,304 $ 18,831 $ 3,473 67 Total research, development and clinical trials expenses increased by $3.5 million from $18.8 million in the year ended December 31, 2020 to $22.3 million in the year ended December 31, 2021. Personnel related costs increased by $0.4 million as a result of increased stock-based compensation expense due to additional grants to new and existing employees and an increase in the respective grant date fair values from the increased price of our stock. Clinical trials costs decreased by $1.5 million due to the completion of enrollment in the OCS Heart DCD CAP Trial and completion of our OCS Liver PROTECT CAP Trial in 2021. Consulting and third-party testing costs increased by $2.8 million due primarily to increased activity in our next generation program and increased regulatory activity, including costs related to preparation for both FDA advisory committee panels in April and July 2021 for the OCS Heart and OCS Liver, respectively. The increase in laboratory supplies and research materials costs of $0.7 million was driven by increased research activity related to our next generation program and other product enhancement initiatives. The increase in other costs of $1.0 million was due primarily to increased product development activities and increased spending on facilities, travel, and risk management as restrictions related to COVID-19 were relaxed in 2021 as compared to the previous year. Selling, General and Administrative Expenses Year Ended December 31, 2021 2020 Change (in thousands) Personnel related (including stock-based compensation expense) $ 21,202 $ 12,292 $ 8,910 Professional and consultant fees 7,032 5,479 1,553 Tradeshows and conferences 1,445 931 514 Other 8,604 5,486 3,118 Total selling, general and administrative expenses $ 38,283 $ 24,188 $ 14,095 Total selling, general and administrative expenses increased by $14.1 million from $24.2 million in the year ended December 31, 2020 to $38.3 million in the year ended December 31, 2021 . Personnel related costs increased by $8.9 million as a result of the continued expansion of our commercial team including National OCS Program resources to support commercial sales of our OCS Lung, OCS Heart and OCS Liver products in the United States. Stock-based compensation expense also increased by $3.7 million due primarily to additional grants to new and existing employees and an increase in the respective grant date fair values from the increased price of our stock. Professional and consultant fees increased by $1.6 million as a result of additional public company compliance costs. Tradeshows and conferences costs increased by $0.5 million due to a partial return of tradeshow and conference activity as restrictions implemented in response to the COVID-19 pandemic were eased. Other costs increased by $3.1 million as a result of increased spending on travel and insurance as restrictions related to COVID-19 were relaxed in 2021 as compared to the previous year and we expanded our organization. Other Income (Expense) Interest Expense Interest expense was $3.9 million and $4.0 million for the years ending December 31, 2021 and 2020, respectively. Other Income (Expense), Net Other income (expense), net for the years ended December 31, 2021 and 2020 included interest income of $0.1 million and $0.7 million, respectively, resulting from interest earned on invested cash balances. Other income (expense), net also included $1.0 million of realized and unrealized foreign currency transaction losses and $1.0 million of realized and unrealized foreign currency transaction gains, respectively. Interest income decreased from 2020 to 2021 as a result of lower invested balances. Liquidity and Capital Resources Since our inception, we have incurred significant operating losses. To date, we have funded our operations primarily with proceeds from sales of preferred stock and borrowings under loan agreements, proceeds from the sale of common stock in our public offerings and revenue from clinical trials and commercial sales of our OCS products. As of December 31, 2021, we had cash, cash equivalents, and marketable securities of $92.5 million. 68 Cash Flows The following table summarizes our sources and uses of cash for each of the periods presented: Year Ended December 31, 2021 2020 (in thousands) Cash used in operating activities $ (28,864 ) $ (30,265 ) Cash provided by (used in) investing activities 29,267 (41,598 ) Cash provided by financing activities 1,393 75,549 Effect of exchange rate changes on cash, cash equivalents and restricted cash (797 ) 803 Net increase in cash, cash equivalents and restricted cash $ 999 $ 4,489 Operating Activities During the year ended December 31, 2021, operating activities used $28.9 million of cash, primarily resulting from our net loss of $44.2 million, partially offset by net non-cash charges of $12.3 million and net cash provided by changes in our operating assets and liabilities of $3.0 million. Net cash provided by changes in our operating assets and liabilities for the year ended December 31, 2021 consisted primarily of an increase in accounts payable and accrued expenses and other current liabilities of $10.0 million and a decrease in accounts receivable of $0.8 million, partially offset by an increase in inventory of $4.9 million and an increase in prepaid expenses and other current assets of $3.2 million. During the year ended December 31, 2020, operating activities used $30.3 million of cash, primarily resulting from our net loss of $28.7 million and net cash used by changes in our operating assets and liabilities of $5.6 million, partially offset by net non-cash charges of $4.1 million. Net cash used by changes in our operating assets and liabilities for the year ended December 31, 2020 consisted primarily of a $3.9 million decrease in accounts payable and accrued expenses and other current liabilities, a $1.7 million increase in inventory and a $0.8 million increase in prepaid expenses and other current assets, partially offset by a $0.9 million increase in deferred rent. Changes in accounts receivable, inventory, accounts payable, and accrued expenses and other current liabilities in each reporting period are generally due to growth in our business and timing of invoices and payments. Investing Activities During the year ended December 31, 2021, net cash provided by investing activities of $29.3 million consisted of proceeds from sales and maturities of marketable securities of $104.8 million, partially offset by $72.0 million in purchases of marketable securities and $3.5 million in purchases of property and equipment. During the year ended December 31, 2020, net cash used in investing activities of $41.6 million consisted of $121.8 million in purchases of marketable securities and $0.5 million in purchases of property and equipment, partially offset by proceeds from sales and maturities of marketable securities of $80.7 million. Financing Activities During the year ended December 31, 2021, net cash provided by financing activities of $1.4 million consisted of proceeds from the issuance of common stock upon exercise of stock options of $1.0 million and proceeds from the issuance of common stock in connection with the employee stock purchase plan of $0.4 million. During the year ended December 31, 2020, net cash provided by financing activities of $75.5 million consisted primarily of proceeds from the issuance of common stock in our May 2020 public offering of $75.7 million and our employee share ownership plans of $0.6 million, both partially offset by payments of offering costs of $0.7 million. Long-Term Debt We have a Credit Agreement with OrbiMed, pursuant to which we borrowed $35.0 million. Borrowings under the Credit Agreement bear interest at an annual rate equal to the LIBOR subject to a minimum of 1.0% and a maximum of 4.0%, plus 8.5%, or the Applicable Margin, subject in the aggregate to a maximum interest rate of 11.5%. In addition, borrowings under the Credit Agreement bear paid-in-kind, or PIK interest, at an annual rate equal to the amount by which LIBOR plus the Applicable Margin exceeds 11.5%, but not to exceed 12.5%. The PIK interest is added to the principal amount of the borrowings outstanding at the end of each quarter until the maturity date of the Credit Agreement in June 2023. Borrowings 69 under the Credit Agreement are repayable in quarterly interest-only payments until the maturity date, at which time all principal and accrued interest is due and payable. At our option, we may prepay outstanding borrowings under the Credit Agreement . We are also required to make a final payment in an amount equal to 3.0% of the principal amount of any prepayment or repayment, which we are accreting to interest expense over the term of the Credit Agreement using the effective interest method. All obligations under the Credit Agreement are guaranteed by us and each of our material subsidiaries. All obligations of us and each guarantor are secured by substantially all of our and each guarantor’s assets, including their intellectual property, subject to certain exceptions, including a perfected security interest in substantially all tangible and intangible assets of us and each guarantor. Under the Credit Agreement, we have agreed to certain affirmative and negative covenants to which we will remain subject until maturity. The financial covenants include maintaining a minimum liquidity amount of $3.0 million; the requirement, on an annual basis, to deliver to OrbiMed annual audited financial statements with an unqualified audit opinion from our independent registered public accounting firm; and restrictions on our activities, including limitations on dispositions, mergers or acquisitions; encumbering our intellectual property; incurring indebtedness or liens; paying dividends; making certain investments; and engaging in certain other business transactions. The obligations under the Credit Agreement are subject to acceleration upon the occurrence of specified events of default, including payment default, change in control, bankruptcy, insolvency, certain defaults under other material debt, certain events with respect to governmental approvals (if such events could cause a material adverse change in our business), failure to comply with certain covenants, including the minimum liquidity and unqualified audit opinion covenants, and a material adverse change in our business, operations or other financial condition. As of December 31, 2021, we were in compliance with all of the covenants under the Credit Agreement. Upon the occurrence of an event of default and until such event of default is no longer continuing, the Applicable Margin will increase by 4.0% per annum. If an event of default (other than certain events of bankruptcy or insolvency) occurs and is continuing, OrbiMed may declare all or any portion of the outstanding principal amount of the borrowings plus accrued and unpaid interest to be due and payable. Upon the occurrence of certain events of bankruptcy or insolvency, all of the outstanding principal amount of the borrowings plus accrued and unpaid interest will automatically become due and payable. In addition, we may be required to prepay outstanding borrowings, subject to certain exceptions, with portions of net cash proceeds of certain asset sales and certain casualty and condemnation events. While we do not expect that the transition from LIBOR, including any legal or regulatory changes made in response to its future phase out, or the risks related to its discontinuance will have a material effect on our financing costs, the impact is uncertain at this time. Funding Requirements As we continue to pursue and increase commercial sales of our OCS products, we expect our costs and expenses to increase in the future, particularly as we expand our commercial team, grow our National OCS Program, scale our manufacturing operations, continue research, development and clinical trial efforts, and seek regulatory approval for new products and product enhancements, including new indications, both in the United States and in select non-U.S. markets. In addition, following the closing of our IPO, we have incurred and expect to continue to incur additional costs associated with operating as a public company. The timing and amount of our operating and capital expenditures will depend on many factors, including: • the amount of net revenue generated by sales of our OCS Consoles, OCS disposable sets and other products that may be approved in the United States and select non-U.S. markets; • the costs and expenses of expanding our U.S. and non-U.S. sales and marketing infrastructure and our manufacturing operations; • the extent to which our OCS products are adopted by the transplant community; • the ability of our customers to obtain adequate reimbursement from third-party payors for procedures performed using the OCS products; • the degree of success we experience in commercializing our OCS products for additional indications; • the costs, timing and outcomes of post-approval studies or any future clinical studies and regulatory reviews, including to seek and obtain approvals for new indications for our OCS products; • the emergence of competing or complementary technologies; 70 • the number and types of future products we develop and commercialize; • the costs associated with building our commercial operations; • the costs of preparing, filing and prosecuting patent applications and maintaining, enforcing and defending intellectual property-related claims; and • the level of our selling, general and administrative expenses. We believe that our existing cash, cash equivalents and marketable securities will enable us to fund our operating expenses, capital expenditure requirements, and debt service payments for at least 12 months following the filing of our annual report on Form 10-K. We may need to raise additional funding, which might not be available on favorable terms or at all. See “Item 1A. Risk Factors—Risks Related to Our Financial Position and Need for Additional Capital” in this Annual Report on Form 10-K. Material Contractual Obligations Our contractual obligations include amounts payable as principal and interest payments under the Credit Agreement. As of December 31, 2021, our outstanding principal balance was $35.0 million and is due in 2023. We estimate we will pay $3.3 million in interest payments during 2022. Our estimate of payments is based on an assumed rate of 9.5%, which was the interest rate in effect at December 31, 2021. Because such interest rate is below the PIK interest threshold of 11.5%, we did not include PIK in our calculated payments. We lease our facilities under non-cancelable operating leases that have remaining lease terms of six years as of December 31, 2021. As of December 31, 2021, we had fixed lease payment obligations of $12.4 million, of which $1.9 million is payable during 2022. In January 2021, we entered into an unconditional $9.5 million purchase commitment in the ordinary course of business, for goods with specified annual minimum quantities to be purchased through December 2029. The contract is not cancellable without penalty. As of December 31, 2021, our remaining purchase commitment is $8.0 million. We also enter into other contracts in the normal course of business with consulting firms, material suppliers and other third parties for clinical trials and testing and manufacturing services. These contracts do not contain minimum purchase commitments and are cancelable by us upon prior written notice. Payments due upon cancellation consist only of payments for services provided or expenses incurred, including noncancelable obligations of our service providers, up to the date of cancellation. These payments are not included in the discussion above as the amount and timing of such payments are not known. Critical Accounting Policies and Significant Judgments and Estimates Our consolidated financial statements are prepared in accordance with generally accepted accounting principles in the United States. The preparation of our consolidated financial statements and related disclosures requires us to make estimates, assumptions and judgments that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures. We evaluate our estimates on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our consolidated financial statements. Revenue Recognition We generate revenue primarily from sales of our single-use, organ-specific disposable sets (i.e., our organ-specific OCS Perfusion Sets sold together with our organ-specific OCS Solutions) used on our organ-specific OCS Consoles, each being a component of our OCS products. To a lesser extent, we also generate revenue from the sale of OCS Consoles to customers and from the implied rental of OCS Consoles loaned to customers at no charge. For each new transplant procedure, customers purchase an additional OCS disposable set for use on the customer’s existing organ-specific OCS Console. 71 We recognize revenue from sales to customers applying the following five steps: (1) identification of the contract, or contracts, with a customer, (2) identification of the performance obligations in the contract, (3) determination of the transaction price, (4) allocation of the transaction price to the performance obligations in the contract, and (5) recognition of revenue when, or as, performance obligations are satisfied. Substantially all of our customer contracts have multiple-performance obligations that contain deliverables consisting of OCS Perfusion Sets and OCS Solutions. In some of those customer contracts, the deliverables also include an OCS Console. We evaluate each promise within a multiple-performance obligation arrangement to determine whether it represents a distinct performance obligation. The primary performance obligations in our customer arrangements from which we derive revenue are the OCS Perfusion Sets, the OCS Solutions and the OCS Console. Revenue for each OCS Perfusion Set and OCS Solutions is recognized at the point in time at which control is transferred to the customer, which is when title transfers to the customer, typically upon arrival at the customer site. When a customer order includes an OCS Console, we have determined that customer training and the equipment set-up of the OCS Console, each performed by us, are not distinct because they are not sold on a standalone basis and can only be performed by us in conjunction with a sale or loan of our OCS Console. In addition, we have determined that the OCS Console itself is not distinct because the customer cannot benefit from the OCS Console without the training and equipment set-up having been completed. As a result, when the order includes an OCS Console, we have concluded that training, OCS Console equipment set-up, and the OCS Console itself are highly interdependent and represent a single, combined performance obligation. We recognize revenue from the single, combined performance obligation only once the OCS Console has arrived at the customer site and the training and equipment set-up have been completed by us. Customer orders may include the loan of an OCS Console as well as OCS disposable sets. When we loan the OCS Console to the customer, we retain title to the console at all times and do not require minimum purchase commitments from the customer related to any OCS products. In such cases, we invoice the customer for OCS disposable sets based on customer orders received and the prices set forth in the customer agreement. Over time, we typically recover the cost of the loaned OCS Console through the customer’s continued purchasing of OCS disposable sets. For these reasons, we have determined that part of the arrangement consideration for the disposable set is an implied rental payment for use of the OCS Console. Therefore, we allocate the arrangement consideration between the lease deliverables (i.e., the OCS Console) and non-lease deliverables (i.e., the OCS disposable sets) based on the relative estimated standalone selling price of each distinct performance obligation. To date, the amounts allocated to lease deliverables have been insignificant. Because all performance obligations of a customer order are delivered and recognized as revenue at the same time and because revenue allocated to performance obligations other than OCS disposable sets, such as implied rental income and service revenue, is insignificant, all components of revenue from customer arrangements are classified as a single category of revenue in our consolidated statements of operations. Revenue is recognized when control of the OCS product or products is transferred to the customer in an amount that reflects the consideration we expect to be entitled to in exchange for the product or products. Payments Made to Customers Under our customer arrangements that include a customer clinical trial agreement, we make payments to that customer for reimbursements of clinical trial costs, materials, and for specified clinical documentation related to the customer’s use of our OCS products. We also make payments to customers involved in post-approval studies for information related to the transplant procedures performed. We determine the appropriate accounting treatments for these payments depending on the nature of the payment and whether they are for distinct goods or services. Other Revenue Considerations Revenue is reported net of taxes. We do not consider shipping to be a contract performance obligation, therefore shipping costs incurred and billed to customers are recorded as revenue and cost of revenue. We only include estimated variable amounts in the transaction price to the extent it is probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved. We do not assess whether promised goods or services are performance obligations if they are deemed immaterial in the context of the contract with the customer. Additionally, we do not assess whether a contract has a significant financing component if the expectation at contract inception is that the period between payment by the customer and the transfer of the promised goods or services to the customer will be one year or less. 72 Stock-Based Compensation We measure stock-based option awards granted to employees, directors and non-employees based on their fair value on the date of the grant using the Black-Scholes option-pricing model. Compensation expense for those awards is recognized over the requisite service which is generally the vesting period of the respective award. Generally, we issue awards with only service-based vesting conditions and record the expense for these awards using the straight-line method. We account for forfeitures as they occur and record compensation cost assuming all option holders will complete the requisite service period. If an award is forfeited, we reverse compensation expense previously recognized in the period the award is forfeited. The Black-Scholes option-pricing model uses as inputs the fair value of our common stock and assumptions we make for the volatility of our common stock, the expected term of our common stock options, the risk-free interest rate for a period that approximates the expected term of our common stock options, and our expected dividend yield. Valuation of Inventory We value inventory at the lower of cost or net realizable value, with cost computed using the first-in, first-out method. We regularly review inventory quantities on-hand for excess and obsolete inventory and, when circumstances indicate, record charges to write down inventories to their estimated net realizable value, after evaluating historical sales, future demand, market conditions and expected product life cycles. Such charges are classified as cost of revenue in our consolidated statements of operations. Any write-down of inventory to net realizable value creates a new cost basis. The reserve for excess and obsolete inventory was $0.3 million as of December 31, 2021 and 2020. At the end of each reporting period, we assess whether losses should be accrued on long-term manufacturing purchase commitments in accordance with ASC 330, Inventory , which requires that losses that are expected to arise from firm, noncancelable and unhedged commitments for the future purchase of inventory, measured in the same way as inventory losses, should be recognized in the current period in the statements of operations unless they are deemed recoverable through firm sales contacts or when there are other circumstances that reasonably assure continuing sales without price decline. As of the end of each reporting period presented in our consolidated financial statements included elsewhere in this Annual Report on Form 10-K, we did not identify any potential losses arising from remaining future purchase commitments as compared to estimated future customer sales through the remainder of the term of the manufacturing purchase commitment and, as a result, did not recognize in a current period any loss provision for future-period remaining purchase commitments. Backlog We define backlog as contractually committed orders for our products for which the associated revenue has not been recognized and the customer has not been invoiced. Amounts that have been invoiced but not yet recognized as revenue are reported as deferred revenue on our consolidated balance sheets and are not included in our calculation of backlog. As of December 31, 2021 and 2020, we had backlog of $1.1 million and $0.5 million, respectively. Of the amount of backlog as of December 31, 2021, we expect that substantially all of it will be invoiced to customers within the following 12 months. However, because our customers may cancel, change or reschedule orders without penalty at any time prior to shipment, we have no assurance that we will be able to convert our backlog into shipped orders. Off-Balance Sheet Arrangements We did not have during the periods presented, and we do not currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the SEC. Recently Issued Accounting Pronouncements A description of recently issued accounting pronouncements that may potentially impact our financial position, results of operations or cash flows is disclosed in Note 2 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. 73