PENUMBRA, INC. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management's discussion and analysis of financial condition and results of operations for the year endedDecember 31, 2019 , included in our Annual Report on Form 10-K filed with theSecurities and Exchange Commission ("SEC") onFebruary 26, 2020 . This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the "Exchange Act"). In some cases, you can identify these statements by forward-looking words such as "may," "will," "expect," "believe," "anticipate," "intend," "could," "should," "estimate," or "continue," and similar expressions or variations. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results and timing expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled "Risk Factors" in Part I, Item 1A of our Annual Report on Form 10-K for the year endedDecember 31, 2019 . The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report on Form 10-Q. Except as may be required by law, we assume no obligation to update these forward-looking statements or the reasons that results could differ from these forward-looking statements. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q. Overview Penumbra is a global healthcare company focused on innovative therapies. We design, develop, manufacture and market novel products and have a broad portfolio that addresses challenging medical conditions in markets with significant unmet need. Our team focuses on developing, manufacturing and marketing novel products for use by specialist physicians and healthcare providers to drive improved clinical outcomes. We believe that the cost-effectiveness of our products is attractive to our customers. Since our founding in 2004, we have invested heavily in our product development capabilities in our major markets: neuro and vascular. We have successfully developed, obtained regulatory clearance or approval for, and introduced products into the neurovascular market since 2007, vascular market since 2013 and neurosurgical market since 2014, respectively. We continue to expand our portfolio of product offerings, while developing and iterating on our currently available products. We expect to continue to develop and build our portfolio of products, including our thrombectomy, embolization and access technologies. Generally, when we introduce a next generation product or a new product designed to replace a current product, sales of the earlier generation product or the product replaced decline. Our research and development activities are centered around the development of new products and clinical activities designed to support our regulatory submissions and demonstrate the effectiveness of our products. To address the challenging and significant clinical needs of our two key markets, we developed products that fall into the following broad product offering families: Our neuro products fall into five broad product families: •Neuro thrombectomy - Penumbra System, including Penumbra JET, ACE and the 3D Revascularization Device, Penumbra ENGINE and other components and accessories •Neuro embolization - Penumbra SMART COIL, Penumbra Coil 400, POD400 and PAC400 •Neuro access - delivery catheters, consisting of Neuron, Neuron MAX, Select, BENCHMARK,DDC and PX SLIM •Neurosurgical - Artemis Neuro Evacuation Device •Rehabilitation Tools - REAL Immersive System Our vascular products fall into two broad product families: •Vascular thrombectomy - INDIGO System designed for mechanical thrombectomy, including aspiration catheters, separators, aspiration pump and accessories and Lightning 12, our next-generation aspiration system for peripheral thrombectomy 24
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•Peripheral embolization - RUBY Coil System, LANTERN Delivery Microcatheter and the POD System (POD and POD Packing Coil) We sell our products to hospitals and other healthcare providers primarily through our direct sales organization inthe United States , most ofEurope ,Canada andAustralia , as well as through distributors in select international markets. In the nine months endedSeptember 30, 2020 and 2019, 28.0% and 35.6% of our revenue, respectively, was generated from customers located outside ofthe United States . Our sales outside ofthe United States are denominated principally in the euro and Japanese yen, with some sales being denominated in other currencies. As a result, we have foreign exchange exposure but do not currently engage in hedging. We generated revenue of$393.5 million and$402.1 million for the nine months endedSeptember 30, 2020 and 2019, respectively, a decrease of$8.6 million . We generated an operating loss of$37.2 million and operating income of$36.9 million for the nine months endedSeptember 30, 2020 and 2019, respectively. COVID-19 Pandemic InMarch 2020 , theWorld Health Organization declared the outbreak of COVID-19 as a pandemic, which continues to spread throughout theU.S. and the world. In response, governments have issued orders restricting certain activities, and while our business falls within the category of healthcare operations, which are essential businesses currently permitted to continue operating during the COVID-19 outbreak, we have experienced, and expect to continue to experience, disruptions to our operations as a result of the pandemic. For example, hospital resources have been diverted to fight the pandemic, and many government agencies in conjunction with healthcare systems have recommended the deferral of elective and semi-elective medical procedures during the outbreak. Some of Penumbra's medical devices are used in certain procedures that theUnited States Centers for Medicare & Medicaid Services ("CMS") has indicated are "high-acuity" procedures that should not be postponed during the outbreak in itsMarch 18, 2020 recommendations, while other Penumbra devices are used in elective procedures that physicians may consider postponing. Many of the procedures in which our vascular products are used are elective in nature, whereas procedures in which our neuro products are used, such as stroke, tend to be more emergent in nature. The impact of COVID-19 on our business remains fluid, and we continue to actively monitor the dynamic situation. We will continue to undertake the following specific actions and strategic priorities to navigate the pandemic: •We have made changes to how we manufacture, inspect and ship our products to prioritize the health and safety of our employees and to operate under the protocols mandated by our local and state governments. While we are committed to continue meeting demand for our essential devices, we have implemented social distancing and other measures to protect the health and safety of our employees, which have reduced, and may continue to reduce, our manufacturing capacity. •In order to strengthen our liquidity position, we issued and sold an aggregate of 865,963 shares of our common stock at a public offering price of$166.00 per share, less the underwriters' discounts and commissions, pursuant to an underwritten public offering inJune 2020 . We received approximately$134.8 million in net cash proceeds from the offering after deducting underwriting discounts and commissions of$8.6 million and other offering expenses of$0.4 million . •We further strengthened our liquidity position by entering into a Credit Agreement (the "Credit Agreement") onApril 24, 2020 , withJPMorgan Chase Bank, N.A ., as administrative agent and lender, andBank of America, N.A . andCitibank, N.A . as lenders. The Credit Agreement is secured and provides for up to$100 million in available revolving borrowing capacity with an option, subject to certain conditions, for us to increase the aggregate borrowing capacity to up to$150 million , and matures onApril 23, 2021 . This revolving line of credit provides access to capital beyond the$268.7 million in cash, cash equivalents and marketable investments on our balance sheet as ofSeptember 30, 2020 , and we believe this will allow us to both navigate the current environment and emerge in a strong liquidity position after the pandemic. As ofSeptember 30, 2020 , the Company was not in compliance with the requirement in the Credit Agreement to maintain a minimum fixed charge coverage ratio. The Company subsequently obtained a waiver of such non-compliance from the lenders under the Credit Agreement. As ofSeptember 30, 2020 , there were no borrowings outstanding under the Credit Agreement. •We will continue to prioritize investments in our production capacity and flexibility, commercial channels, preparation for new product launches, and new product developments to help patients. While we have seen positive trends in certain areas of our business beginning in May, we remain mindful of the negative impacts on business trends we experienced in April due to the COVID-19 outbreak. The general impact of COVID-19 on our business has been negative and we are unable to reliably predict the full impact that COVID-19 will have on our business due to 25
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numerous uncertainties, including the severity and duration of the outbreak, the global resurgences of cases, additional actions that may be taken by governmental authorities in response to the outbreak, the impact of the outbreak on the business of our customers, distributors and suppliers, other businesses and worldwide economies in general, our ability to have access to our customers to provide training and case support, and other factors identified in Part II, Item 1A "Risk Factors" in this Quarterly Report on Form 10-Q. We will continue to evaluate the nature and extent of the impact of COVID-19 on our business, consolidated results of operations, and financial condition. Factors Affecting Our Performance There are a number of factors that have impacted, and we believe will continue to impact, our results of operations and growth. These factors include: •The COVID-19 outbreak and measures taken in response thereto, which have negatively affected, and we expect will continue to negatively affect, our revenues and results of operations. Due to these impacts and measures, we may experience significant and unpredictable fluctuations in demand for certain of our products as hospital customers re-prioritize the treatment of patients and distributors adjust their operations to support the current demand level. •The rate at which we grow our salesforce and the speed at which newly hired salespeople become fully effective can impact our revenue growth or our costs incurred in anticipation of such growth. •Our industry is intensely competitive and, in particular, we compete with a number of large, well-capitalized companies. We must continue to successfully compete in light of our competitors' existing and future products and their resources to successfully market to the specialist physicianswho use our products. •We must continue to successfully introduce new products that gain acceptance with specialist physicians and successfully transition from existing products to new products, ensuring adequate supply. In addition, as we introduce new products and expand our production capacity, we anticipate additional personnel will be hired and trained to build our inventory of components and finished goods in advance of sales, which may cause quarterly fluctuations in our operating results and financial condition. •Publications of clinical results by us, our competitors and other third parties can have a significant influence on whether, and the degree to which, our products are used by specialist physicians and the procedures and treatments those physicians choose to administer for a given condition. •The specialist physicianswho use our products may not perform procedures during certain times of the year, such as those periods when they are at major medical conferences or are away from their practices for other reasons, the timing of which occurs irregularly during the year and from year to year. •Most of our sales outside ofthe United States are denominated in the local currency of the country in which we sell our products. As a result, our revenue from international sales can be significantly impacted by fluctuations in foreign currency exchange rates. •The availability and levels of reimbursement within the relevant healthcare payment system for healthcare providers for procedures in which our products are used. In addition, we have experienced and expect to continue to experience meaningful variability in our quarterly revenue, gross profit and gross margin percentage as a result of a number of factors, including, but not limited to: the impact of COVID-19, the number of available selling days, which can be impacted by holidays; the mix of products sold; the geographic mix of where products are sold; the demand for our products and the products of our competitors; the timing of or failure to obtain regulatory approvals or clearances for products; increased competition; the timing of customer orders; inventory write-offs due to obsolescence; costs, benefits and timing of new product introductions; costs, benefits and timing of the acquisition and integration of businesses and product lines we may acquire; the availability and cost of components and raw materials; and fluctuations in foreign currency exchange rates. We may experience quarters in which we have significant revenue growth sequentially followed by quarters of moderate or no revenue growth. Additionally, we may experience quarters in which operating expenses, in particular research and development expenses, fluctuate depending on the stage and timing of product development. 26
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Components of Results of Operations Revenue. We sell our products directly to hospitals and other healthcare providers and through distributors for use in procedures performed by specialist physicians to treat patients in two key markets: neuro and vascular disease. We sell our products through purchase orders, and we do not have long term purchase commitments from our customers. Revenue from product sales is recognized either on the date of shipment or the date of receipt by the customer, but is deferred for certain transactions when control has not yet transferred. With respect to products that we consign to hospitals, which primarily consist of coils, we recognize revenue at the time hospitals utilize products in a procedure. Revenue also includes shipping and handling costs that we charge to customers. Cost of Revenue. Cost of revenue consists primarily of the cost of raw materials and components, personnel costs, including stock-based compensation, inbound freight charges, receiving costs, inspection and testing costs, warehousing costs, royalty expense, shipping and handling costs, and other labor and overhead costs incurred in the manufacturing of products. In addition, we record write-downs or write-offs of inventory in the event that a portion of our inventory becomes excess or obsolete. We manufacture substantially all of our products in our manufacturing facilities inAlameda andRoseville, California . Operating Expenses Research and Development ("R&D"). R&D expenses primarily consist of product development, clinical and regulatory expenses, materials, depreciation and other costs associated with the development of our products. R&D expenses also include salaries, benefits and other related costs, including stock-based compensation, for personnel and consultants. We generally expense R&D costs as they are incurred, with the exception of certain costs incurred for the development of computer software for internal use related to our REAL Immersive System offerings. We capitalize certain costs when it is determined that it is probable that the project will be completed and the software will be used to perform the function intended, and the preliminary project stage is completed. Capitalized internal use software development costs are included in property and equipment, net within the condensed consolidated balance sheets. Sales, General and Administrative ("SG&A"). SG&A expenses primarily consist of salaries, benefits and other related costs, including stock-based compensation, for personnel and consultants engaged in sales, marketing, finance, legal, compliance, administrative, facilities and information technology and human resource activities. Our SG&A expenses also include marketing trials, medical education, training, commissions, generally based on sales, to direct sales representatives, amortization of acquired intangible assets and acquisition-related costs. (Benefit from) Provision For Income Taxes We are taxed at the rates applicable within each jurisdiction in which we operate. The composite income tax rate, tax provisions, deferred tax assets ("DTAs") and deferred tax liabilities will vary according to the jurisdiction in which profits arise. Tax laws are complex and subject to different interpretations by management and the respective governmental taxing authorities, and require us to exercise judgment in determining our income tax provision, our deferred tax assets and deferred tax liabilities and the potential valuation allowance recorded against our net DTAs. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the years in which those tax assets are expected to be realized. A valuation allowance is established when it is more likely than not that the future realization of all or some of the DTAs will not be achieved. 27
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Results of Operations
The following table sets forth the components of our condensed consolidated
statements of operations in dollars and as a percentage of revenue for the
periods presented:
Three Months Ended September 30, Nine Months Ended September 30,
2020 2019 2020 2019
(in thousands, except for percentages) (in thousands, except for percentages)
Revenue $ 151,076 100.0 % $ 139,502 100.0 % $ 393,514 100.0 % $ 402,142 100.0 %
Cost of revenue 60,153 39.8 43,504 31.2 149,652 38.0 128,306 31.9
Gross profit 90,923 60.2 95,998 68.8 243,862 62.0 273,836 68.1
Operating expenses:
Research and development 34,923 23.1 13,733 9.8 70,594 17.9 38,862 9.7
Sales, general and
administrative 76,158 50.4 69,289 49.7 210,465 53.5 198,045 49.2
Total operating expenses 111,081 73.5 83,022 59.5 281,059 71.4 236,907 58.9
(Loss) income from operations (20,158) (13.3) 12,976 9.3 (37,197) (9.5) 36,929 9.2
Interest income, net 413 0.3 759 0.5 820 0.2 2,276 0.6
Other income (expense), net 14 - (772) (0.6) (1,130) (0.3) (819) (0.2)
(Loss) income before income
taxes (19,731) (13.1) 12,963 9.3 (37,507) (9.5) 38,386 9.5
(Benefit from) provision for
income taxes (9,855) (6.5) 1,963 1.4 (15,618) (4.0) 683 0.2
Consolidated net (loss) income $ (9,876) (6.5) % $ 11,000 7.9 % $ (21,889) (5.6) % $ 37,703 9.4 %
Net loss attributable to
non-controlling interest (1,061) (0.7) (483) (0.3) (2,539) (0.6) (1,066) (0.3)
Net (loss) income attributable
to Penumbra, Inc. $ (8,815) (5.8) % $ 11,483 8.2 % $ (19,350) (4.9) % $ 38,769 9.6 %
Three Months Ended September 30, 2020 Compared to the Three Months Ended
September 30, 2019
Revenue
Three Months Ended September 30, Change
2020 2019 $ %
(in thousands, except for percentages)
Neuro $ 75,917 $ 83,247 $ (7,330) (8.8) %
Vascular 75,159 56,255 18,904 33.6 %
Total $ 151,076 $ 139,502 $ 11,574 8.3 %
Revenue increased $11.6 million , or 8.3%, to $151.1 million in the three months
ended September 30, 2020 , from $139.5 million in the three months ended
September 30, 2019 . The overall growth in our revenue is primarily due to an
increase in products sales within our vascular business as a result of sales of
new products and further market penetration of our existing products, partially
offset by a decline in sales of products within our neuro business.
Revenue from our neuro products decreased $7.3 million , or 8.8%, to $75.9
million in the three months ended September 30, 2020 , from $83.2 million in the
three months ended September 30, 2019 . This decrease was primarily attributable
to decreased sales of our neuro thrombectomy products which globally declined by
23.2% in the three months ended September 30, 2020 . This decrease was primarily
attributable to decreased sales in Japan as a result of reimbursement changes,
on-going discussions with our distributor partner, and the paused launch of our
new stroke product in that market. This decline was partially offset by an
increase in sales of our neuro access and neuro embolization products, which
globally increased by 35.0% and 9.7%, respectively in the three months ended
September 30, 2020 , due to further market penetration and growth in the market
for endovascular treatment of stroke. Prices for our neuro products remained
substantially unchanged during the period.
Revenue from our vascular products increased $18.9 million , or 33.6%, to $75.2
million in the three months ended September 30, 2020 , from $56.3 million in the
three months ended September 30, 2019 . This increase was driven by sales of
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our vascular thrombectomy products and peripheral embolization products, which globally increased by 49.3% and 17.4%, respectively in the three months endedSeptember 30, 2020 . This increase was primarily due to higher sales volume as a result of sales of new products and further market penetration of our existing products. Prices for our vascular products remained substantially unchanged during the period. Revenue by Geographic Area The following table presents revenue by geographic area, based on our customers' shipping destinations, for the three months endedSeptember 30, 2020 and 2019: Three Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) United States$ 109,656 72.6 %$ 90,272 64.7 %$ 19,384 21.5 % International 41,420 27.4 % 49,230 35.3 % (7,810) (15.9) % Total$ 151,076 100.0 %$ 139,502 100.0 %$ 11,574 8.3 % Revenue from product sales in international markets decreased$7.8 million , or 15.9%, to$41.4 million in the three months endedSeptember 30, 2020 , from$49.2 million in the three months endedSeptember 30, 2019 . Revenue from international sales represented 27.4% and 35.3% of our total revenue for the three months endedSeptember 30, 2020 and 2019, respectively. Gross Margin Three Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) Cost of revenue$ 60,153 $ 43,504 $ 16,649 38.3 % Gross profit$ 90,923 $ 95,998 $ (5,075) (5.3) % Gross margin % 60.2 % 68.8 % Gross margin decreased 8.6 percentage points to 60.2% in the three months endedSeptember 30, 2020 , from 68.8% in the three months endedSeptember 30, 2019 . This gross margin decrease is driven by three components: (i) incremental investments on COVID-19 related safety measures, which include trade-offs made in productivity and capacity; (ii) accelerated investments in direct labor hires and production support to enable production scale-up in ourAlameda andRoseville manufacturing facilities, respectively, undertaken to support new product launches and meet increasing demand in a less efficient manufacturing environment; and (iii) unabsorbed manufacturing variances from the second quarter of 2020 that resulted from inventory sold through in the third quarter. Research and Development ("R&D") Three Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) R&D$ 34,923 $ 13,733 $ 21,190 154.3 % R&D as a percentage of revenue 23.1 %
9.8 %
R&D expenses increased by$21.2 million , or 154.3%, to$34.9 million in the three months endedSeptember 30, 2020 , from$13.7 million in the three months endedSeptember 30, 2019 . The increase was primarily due to a$16.3 million increase in personnel-related expenses, which primarily includes one-time, non-recurring expenses associated with the launch of our Lightning product, and a$4.6 million increase in product development and testing costs. We have made investments, and plan to continue to make investments, in the development of our products, which may include hiring additional research and development employees. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of clinical trials and product development. 29
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Sales, General and Administrative ("SG&A")
Three Months Ended September 30, Change
2020 2019 $ %
(in thousands, except for percentages)
SG&A $ 76,158 $ 69,289 $ 6,869 9.9 %
SG&A as a percentage of revenue 50.4 % 49.7 %
SG&A expenses increased by$6.9 million , or 9.9%, to$76.2 million in the three months endedSeptember 30, 2020 , from$69.3 million in the three months endedSeptember 30, 2019 . The increase was primarily due to a$12.7 million increase in personnel-related expenses, partially offset by a$3.9 million decrease in cost related to marketing events, and a$2.8 million decrease in travel-related expenses. As we continue to invest in our growth, we have expanded and may continue to expand our sales, marketing, and general and administrative teams through the hiring of additional employees. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of investments in infrastructure to support the business. (Benefit from) Provision for Income Taxes Three Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) (Benefit from) provision for income taxes$ (9,855) $ 1,963 $ (11,818) (602.0) % Effective tax rate 49.9 % 15.1 % Our benefit from income taxes was$9.9 million for the three months endedSeptember 30, 2020 , which was primarily due to tax benefits attributable to our worldwide losses, combined with excess tax benefits from stock-based compensation attributable to ourU.S. jurisdiction. Our provision for income taxes was$2.0 million for the three months endedSeptember 30, 2019 , which was primarily due to income taxes attributable to our worldwide profits, offset by excess tax benefits from stock-based compensation attributable to ourU.S. jurisdiction. The effective tax rate was 49.9% for the three months endedSeptember 30, 2020 , compared to 15.1% for the three months endedSeptember 30, 2019 . Our change in effective tax rate was primarily attributable to large tax benefits over worldwide losses for the three months endedSeptember 30, 2020 , when compared to small tax expenses over worldwide profits for the three months endedSeptember 30, 2019 . Nine Months EndedSeptember 30, 2020 Compared to the Nine Months EndedSeptember 30, 2019 Revenue Nine Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) Neuro$ 212,830 $ 246,265 $ (33,435) (13.6) % Vascular 180,684 155,877 24,807 15.9 % Total$ 393,514 $ 402,142 $ (8,628) (2.1) % Revenue decreased$8.6 million , or 2.1%, to$393.5 million in the nine months endedSeptember 30, 2020 , from$402.1 million in the nine months endedSeptember 30, 2019 . The decline in overall revenue is primarily due to a decrease in sales of products within our neuro business, partially offset by an increase in sales of new and existing products within our vascular business. Revenue from our neuro products decreased$33.4 million , or 13.6%, to$212.8 million in the nine months endedSeptember 30, 2020 , from$246.3 million in the nine months endedSeptember 30, 2019 . This was primarily attributable to decreased sales of our neuro thrombectomy products and neuro embolization products, which globally declined by 21.6% and 6.2%, respectively, in the nine months endedSeptember 30, 2020 . This decrease was primarily attributable to: (i) decreased sales inJapan as a result of reimbursement changes, on-going discussions with our distributor partner, and the paused launch of our new stroke product in that market, and (ii) lower sales volume as a result of hospitals performing fewer procedures and a 30
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decline in other international distribution sales, all primarily resulting from the response to the COVID-19 pandemic by hospitals and our distributors. Prices for our neuro products remained substantially unchanged during the period. Revenue from our vascular products increased$24.8 million , or 15.9%, to$180.7 million in the nine months endedSeptember 30, 2020 , from$155.9 million in the nine months endedSeptember 30, 2019 . This increase was driven by sales of our vascular thrombectomy products and peripheral embolization products, which globally increased by 25.1% and 6.5%, respectively, in the nine months endedSeptember 30, 2020 . This increase was primarily due to high sales volume as a result of sales of new products and further market penetration of our existing products. Prices for our vascular products remained substantially unchanged during the period. Revenue by Geographic Area The following table presents revenue by geographic area, based on our customer's shipping destination, for the nine months endedSeptember 30, 2020 and 2019: Nine Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) United States$ 283,473 72.0 %$ 259,157 64.4 %$ 24,316 9.4 % International 110,041 28.0 % 142,985 35.6 % (32,944) (23.0) % Total$ 393,514 100.0 %$ 402,142 100.0 %$ (8,628) (2.1) % Revenue from sales in international markets decreased$32.9 million , or 23.0%, to$110.0 million in the nine months endedSeptember 30, 2020 , from$143.0 million in the nine months endedSeptember 30, 2019 . Revenue from international sales represented 28.0% and 35.6% of our total revenue for the nine months endedSeptember 30, 2020 and 2019, respectively. Gross Margin Nine Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) Cost of revenue$ 149,652 $ 128,306 $ 21,346 16.6 % Gross profit$ 243,862 $ 273,836 $ (29,974) (10.9) % Gross margin % 62.0 % 68.1 % Gross margin decreased 6.1 percentage points to 62.0% in the nine months endedSeptember 30, 2020 , from 68.1% in the nine months endedSeptember 30, 2019 . This decrease in gross margin is driven by three components: (i) incremental investments on COVID-19 related safety measures, which include trade-offs made in productivity and capacity; (ii) accelerated investments in direct labor hires and production support to enable production scale-up in ourAlameda andRoseville manufacturing facilities, respectively, undertaken to support new product launches and meet increasing demand in a less efficient manufacturing environment; and (iii) unabsorbed manufacturing variances due to lower production volume in the first and second quarters of 2020. Research and Development ("R&D") Nine Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) R&D$ 70,594 $ 38,862 $ 31,732 81.7 % R&D as a percentage of revenue 17.9 %
9.7 %
R&D expenses increased by$31.7 million , or 81.7%, to$70.6 million in the nine months endedSeptember 30, 2020 , from$38.9 million in the nine months endedSeptember 30, 2019 . The increase was primarily due to a$19.1 million increase in personnel-related expenses, which primarily includes one-time, non-recurring expenses associated with the launch of our Lightning product, and a$9.5 million increase in product development and testing costs. We have made investments, and plan to continue to make investments, in the development of our products, which may include hiring additional research and development employees. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of clinical trials and product development. 31
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Sales, General and Administrative (SG&A)
Nine Months Ended September 30, Change
2020 2019 $ %
(in thousands, except for percentages)
SG&A $ 210,465 $ 198,045 $ 12,420 6.3 %
SG&A as a percentage of revenue 53.5 % 49.2 %
SG&A expenses increased by$12.4 million , or 6.3%, to$210.5 million in the nine months endedSeptember 30, 2020 , from$198.0 million in the nine months endedSeptember 30, 2019 . The increase was primarily due to a$22.0 million increase in personnel-related expense and a$3.5 million increase in infrastructure costs, partially offset by a$8.3 million decrease in cost related to marketing events, and a$7.3 million decrease in travel-related expenses. As we continue to invest in our growth, we have expanded and may continue to expand our sales, marketing, and general and administrative teams through the hiring of additional employees. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of investments in infrastructure to support the business. (Benefit from) Provision For Income Taxes Nine Months Ended September 30, Change 2020 2019 $ % (in thousands, except for percentages) (Benefit from) provision for income taxes$ (15,618) $ 683 $ (16,301) (2,386.7) % Effective tax rate 41.6 % 1.8 % Our benefit from income taxes was$15.6 million for the nine months endedSeptember 30, 2020 , which was primarily due to tax benefits attributable to our worldwide losses, combined with excess tax benefits from stock-based compensation attributable to ourU.S. jurisdiction. Our provision for income taxes was$0.7 million for the nine months endedSeptember 30, 2019 , which was primarily due to income taxes attributable to our worldwide profits, offset by excess tax benefits from stock-based compensation attributable to ourU.S. jurisdiction. The effective tax rate was 41.6% for nine months endedSeptember 30, 2020 , compared to 1.8% for the nine months endedSeptember 30, 2019 . Our change in effective tax rate was primarily attributable to large tax benefits over worldwide losses for the nine months endedSeptember 30, 2020 , when compared to small tax expenses over worldwide profits for the nine months endedSeptember 30, 2019 . Prospectively, our effective tax rate will likely be driven by (1) permanent differences in taxable income for tax and financial reporting purposes, (2) tax expense attributable to our worldwide profit or tax benefit attributable to our worldwide losses, and (3) discrete tax adjustments such as excess tax benefits related to stock-based compensation. Our income tax provision is subject to volatility as the amount of excess tax benefits can fluctuate from period to period based on the price of our stock, the volume of share-based grants settled or vested, and the fair value assigned to equity awards underU.S. GAAP. In addition, changes in tax law or our interpretation thereof, and changes to our valuation allowance could result with fluctuations in our effective tax rate. Liquidity and Capital Resources As ofSeptember 30, 2020 , we had$482.1 million in working capital, which included$80.1 million in cash and cash equivalents and$188.6 million in marketable investments. As ofSeptember 30, 2020 , we held approximately 22.9% of our cash and cash equivalents in foreign entities. InJune 2020 , we issued and sold an aggregate of 865,963 shares of our common stock at a public offering price of$166.00 per share, less the underwriters' discounts and commissions, pursuant to an underwritten public offering. We received approximately$134.8 million in net cash proceeds from the offering after deducting underwriting discounts and commissions of$8.6 million and other offering expenses of$0.4 million . We intend to use the net proceeds from the offering for general corporate purposes, including working capital, continued development of our products, including research and development and clinical trials, potential acquisitions and other business opportunities. Pending the use of the net proceeds from the offering, we are investing the net proceeds in investment grade, interest bearing securities. 32
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In addition to our existing cash and cash equivalents and marketable investment balances, our principal source of liquidity is our accounts receivable. In order to further strengthen our liquidity position and financial flexibility during the COVID-19 pandemic, onApril 24, 2020 we entered into a Credit Agreement (the "Credit Agreement") withJPMorgan Chase Bank, N.A ., as administrative agent and lender, andBank of America, N.A . andCitibank, N.A . as lenders. The Credit Agreement is secured and provides for up to$100 million in available revolving borrowing capacity with an option, subject to certain conditions, for the Company to increase the aggregate borrowing capacity to up to$150 million , and matures onApril 23, 2021 . As ofSeptember 30, 2020 , the Company was not in compliance with the requirement in the Credit Agreement to maintain a minimum fixed charge coverage ratio. The Company subsequently obtained a waiver of such non-compliance from the lenders under the Credit Agreement. As ofSeptember 30, 2020 , there were no borrowings outstanding under the Credit Agreement. See Note "8. Indebtedness" to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information. We believe our sources of liquidity will be sufficient to meet our liquidity requirements for at least the next 12 months. Our principal liquidity requirements are to fund our operations, expand manufacturing operations which includes, but is not limited to, maintaining sufficient levels of inventory to meet the anticipated demand of our customers, fund research and development activities and fund our capital expenditures. We may also lease or purchase additional facilities to facilitate our growth. We expect to continue to make investments as we launch new products, expand our manufacturing operations and IT infrastructures and further expand into international markets. We may, however, require or elect to secure additional financing as we continue to execute our business strategy. If we require or elect to raise additional funds, we may do so through equity or debt financing, which may not be available on favorable terms, could result in dilution to our stockholders, could result in changes to our capital structure, and could require us to agree to covenants that limit our operating flexibility. While we have strengthened our liquidity position, as a result of the COVID-19 pandemic, we cannot reliably estimate the extent to which the COVID-19 pandemic may impact our cash flow from operations in the fourth quarter and beyond. The following table summarizes our cash and cash equivalents, marketable investments and selected working capital data as ofSeptember 30, 2020 andDecember 31, 2019 : September 30, 2020 December 31, 2019 (in thousands) Cash and cash equivalents $ 80,115 $ 72,779 Marketable investments 188,611 116,610 Accounts receivable, net 112,817 105,901 Accounts payable 14,544 15,111 Accrued liabilities 87,691 67,630 Working capital(1) 482,144 372,086 __________________ (1)Working capital consists of total current assets less total current liabilities. The following table sets forth, for the periods indicated, our beginning balance of cash and cash equivalents, net cash flows provided by (used in) operating, investing and financing activities and our ending balance of cash and cash equivalents: Nine Months Ended September 30, 2020 2019 (in thousands) Cash and cash equivalents and restricted cash at beginning of period$ 72,779 $ 67,850 Net cash (used in) provided by operating activities (31,159) 21,885 Net cash (used in) provided by investing activities (93,923) 31,023 Net cash provided by (used in) financing activities 132,460 (8,457) Cash and cash equivalents and restricted cash at end of period 80,115 111,581
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Net cash (used in) provided by operating activities consists primarily of consolidated net (loss) income adjusted for certain non-cash items (including depreciation and amortization, stock-based compensation expense, inventory write-downs, and changes in deferred tax balances), and the effect of changes in working capital and other activities. Net cash used in operating activities was$31.2 million during the nine months endedSeptember 30, 2020 and consisted of consolidated net loss of$21.9 million and net changes in operating assets and liabilities of$27.5 million , offset by non-cash items of$18.3 million . The change in operating assets and liabilities includes an increase in inventories of$39.9 million , an increase in accounts receivable of$7.4 million and an increase in prepaid expenses and other current and non-current assets of$6.0 million . This was partially offset by an increase in accrued expenses and other non-current liabilities of$26.1 million . Net cash provided by operating activities was$21.9 million during the nine months endedSeptember 30, 2019 and consisted of a consolidated net income of$37.7 million and non-cash items of$25.9 million , offset by net changes in operating assets and liabilities of$41.7 million . The change in operating assets and liabilities includes an increase in inventories of$27.9 million to support our revenue growth, an increase in accounts receivable of$21.5 million , and an increase in prepaid expenses and other current and non-current assets of$3.4 million , partially offset by an increase in accrued expenses and other non-current liabilities of$7.8 million , and an increase in accounts payable of$3.3 million as a result of growth in our business activities.Net Cash (Used In) Provided By Investing Activities Net cash (used in) provided by investing activities relates primarily to purchases of marketable investments, net of proceeds from maturities and sales, and capital expenditures. Net cash used in investing activities was$93.9 million during the nine months endedSeptember 30, 2020 and consisted of purchases of marketable investments, net of proceeds from maturities and sales, of$69.9 million , and capital expenditures of$21.0 million . Net cash provided by investing activities was$31.0 million during the nine months endedSeptember 30, 2019 and consisted of proceeds from maturities and sales of marketable investments, net of purchases, of$51.2 million , partially offset by capital expenditures of$14.1 million . Net Cash Provided By (Used In) Financing Activities Net cash provided by (used in) financing activities primarily relates to payments of employee taxes related to vested restricted stock units, payments towards the reduction of our finance lease obligations and certain acquisition-related payments, and proceeds from exercises of stock options and issuance of common stock. Net cash provided by financing activities was$132.5 million during the nine months endedSeptember 30, 2020 and primarily consisted of proceeds from the issuance of common stock, net of issuance costs, of$134.8 million , proceeds from the issuance of common stock under our employee stock purchase plan of$5.9 million , and proceeds from exercises of stock options of$4.4 million . This was partially offset by$8.6 million of payments of employee taxes related to vested restricted stock and restricted stock units,$3.1 million in payments towards finance leases, and$0.7 million related to contingent consideration payments made in the first quarter of 2020 in connection with our acquisition of Crossmed in 2017. Net cash used in financing activities was$8.5 million during the nine months endedSeptember 30, 2019 and primarily consisted of$16.1 million of payments of employee taxes related to vested restricted stock and restricted stock units and$1.2 million primarily related to contingent consideration payments made in the first quarter of 2019 in connection with our acquisition of Crossmed in 2017. This was partially offset by proceeds from the issuance of common stock under our employee stock purchase plan of$4.8 million and proceeds from stock option exercises of$3.6 million . Contractual Obligations and Commitments There have been no material changes to our contractual obligations and commitments as ofSeptember 30, 2020 from those disclosed in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Off-Balance Sheet Arrangements We do not have any significant off-balance sheet arrangements or holdings in variable interest entities. 34
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Critical Accounting Policies and Estimates We have prepared our financial statements in accordance withU.S. GAAP. Our preparation of these financial statements requires us to make estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, expenses, and related disclosures at the date of the financial statements, as well as revenue and expenses recorded during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience 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 could therefore differ materially from these estimates under different assumptions or conditions. There have been no material changes to our critical accounting policies from those described in "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in our Annual Report on Form 10-K for the year endedDecember 31, 2019 . Recently Issued Accounting Standards For information with respect to recently issued accounting standards and the impact of these standards on our condensed consolidated financial statements, see Note "2. Summary of Significant Accounting Policies" to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q. 35
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