Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

The following discussion of our financial condition and results of operations should be read together with our audited financial statements and related notes and other financial information included elsewhere in this Annual Report. The following discussion contains forward-looking statements that reflect our current plans, estimates and beliefs. Our actual results could differ materially from those discussed in the forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report, particularly in the section titled “Risk Factors.” Our historical results are not necessarily indicative of the results that may be expected for any period in the future.

Overview

Our technology is designed to elevate the dialysis experience for patients, and help providers overcome traditional care delivery challenges. Requiring only an electrical outlet and tap water to operate, Tablo frees patients and providers from the burdensome infrastructure required to operate traditional dialysis machines. The integration of water purification and on-demand dialysate production enables Tablo to serve as a dialysis clinic on wheels and allows providers to standardize to a single technology platform from the hospital to the home. Tablo is also intelligent and connected, with automated documentation and the ability to integrate with electronic medical record reporting, along with streamlined remote machine management to maximize device uptime. We have generated meaningful evidence to demonstrate that providers can realize significant operational efficiencies, including reducing the cost of their dialysis programs by up to 80% in the intensive care unit. In addition, Tablo has been shown to deliver robust clinical care. In studies we have conducted, patients have reported experiencing fewer symptoms and better quality sleep while on Tablo. We believe Tablo empowers patients, who have traditionally been passive recipients of care, to regain agency and ownership of their treatment. Tablo is cleared by the U.S. Food and Drug Administration (FDA) for use in the hospital, clinic or home setting.

We designed Tablo from the ground up to be a single enterprise solution that can be utilized across the continuum of care, allowing dialysis to be delivered anytime, anywhere and by anyone. Tablo is comprised of a compact console with integrated water purification, on-demand dialysate production and a simple-to-use touchscreen interface. With Tablo, we are bringing data to dialysis. Tablo is built to live in a connected setting with cloud-based system monitoring, patient analytics, remote treatment monitoring and clinical recordkeeping and the ability to activate new capabilities and enhancements through wireless software updates. Tablo’s data analytics and connectivity also enable predictive preventative maintenance to maximize machine uptime. Unlike existing hemodialysis machines, which have limited clinical versatility across care settings and are generally burdened by specialized and expensive infrastructure, Tablo is a single enterprise solution that can be seamlessly utilized across different care settings and for multiple clinical needs.

Driving adoption of Tablo in the acute care setting has been our primary focus to date. We have invested in growing our economic and clinical evidence, built a veteran sales and clinical support team with significant expertise, and implemented a comprehensive training and customer experience program. Our experience in the acute market has demonstrated Tablo’s clinical flexibility and operational versatility, while also delivering meaningful cost savings to the providers. We plan to continue leveraging our commercial infrastructure to broaden our installed base in the acute care market as well as driving utilization and fleet expansion with our existing customers.

We sell our solution through our direct sales organization, which covers most major metropolitan markets in the United States. As of December 31, 2020, our sales organization is comprised of 32 capital sales team members, responsible for generating new customer demand for Tablo, and 47 clinical sales team members responsible for driving utilization and fleet expansion of Tablo consoles at existing customer sites. In addition, our field service team comprised of 69 members provides maintenance services and product support to Tablo customers. The same sales organization and field service team drive Tablo penetration in both the acute and home markets. We believe the ability to leverage one team to serve both markets will result in significant productivity and cost optimization as we continue to scale our business.

We are executing a well-defined, three-pronged strategy designed to expand gross margins. First, we have insourced our console manufacturing to help lower console cost. Second, we are adding a second-source contract manufacturer for our cartridges to gain higher efficiency and lower material cost. Third, we will continue to utilize our cloud-based data system, as well as enhanced product performance, to help drive down the cost of service.

We generate revenue primarily from the initial sale of Tablo consoles, and recurring sales of per-treatment consumables, including the Tablo cartridge, which generates significant total revenue over the life of the console. We generate additional revenue via annual service contracts and shipping and handling charged to customer. Our total revenue was $49.9 million, $15.1 million and $2.0 million for the years ended December 31, 2020, 2019 and 2018, respectively. For the years ended December 31, 2020, 2019 and 2018, we incurred net losses of $121.5 million, $68.3 million and $49.8 million, respectively. As of December 31, 2020, we had an accumulated deficit of $494.1 million.

Initial Public Offering

On September 17, 2020, we completed our IPO, in which we sold 10,293,777 shares of common stock (which included 1,342,666 shares that were offered and sold pursuant to the full exercise of the IPO underwriters’ option to purchase additional shares in connection with the IPO) at a price to the public of $27.00 per share. Including the full exercise of the underwriters’ option to purchase additional shares, we received aggregate net proceeds of approximately $254.8 million after deducting offering costs, underwriting discounts and commissions of approximately $23.1 million. Upon the closing of the IPO, all of our outstanding redeemable convertible preferred stock automatically converted into shares of common stock.

Factors Affecting Our Business

We believe that the COVID-19 pandemic has highlighted the limitations of traditional machines and the benefits of Tablo, driving an increase in demand for Tablo during the second and third quarters of 2020. We also believe the advantages of Tablo highlighted by the pandemic are now embedded as one of the many factors driving our customers’ purchasing decisions and do not expect to experience significant revenue driven solely by COVID-19 in future periods. However, the duration and extent of the COVID-19 pandemic are uncertain, and we cannot predict with certainty the full impact of the COVID-19 pandemic and related containment measures on our business.

In order to operate in a safe manner, we are following the health and safety guidelines of the U.S. Centers for Disease Control and Prevention, Occupational Safety and Health Administration, and local and state public health departments where we operate. We have restricted non-essential travel by our employees, and the majority of our employees at our headquarters have been asked to work from home, with only limited access given to employees to work in the office. For roles that require employees to be physically on-site, such as our R&D and manufacturing technical staff, we have and continue to provide protective equipment, practice social distancing, enforce mask wearing, increase sanitizing standards and implement COVID-19 testing at our facilities. In addition, we have created a business continuity plan and incident management team to respond quickly and effectively to changes in order to offer customers uninterrupted products, services and support while safeguarding the best interest of employees, suppliers and stockholders.

Our business may also be impacted by an escalation or a continuation of the COVID-19 pandemic. Operations at our contract manufacturing partners’ facilities and our outsourced business administration service provider, Tacna, for our new facility in Tijuana, Mexico, may be disrupted. Additionally, the COVID-19 pandemic has disrupted the operations of certain of our third-party suppliers, resulting in increased lead-times for our purchase of some components and, in certain cases, requiring us to procure materials from alternative sources or incur higher logistics expenses. We have worked closely with our manufacturing partners and suppliers to enable us to source key components and maintain appropriate inventory levels to meet customer demand and have not experienced disruptions in our supply chain to date. However, we cannot predict how long the pandemic and measures intended to contain the spread of COVID-19 will continue and what effect COVID-19 and the associated containment measures will have on our suppliers and vendors, in particular for any of our suppliers and vendors that may not qualify as essential businesses and suffer more significant disruptions to their business operations. There is no assurance that we will not experience more significant disruptions in our supply chain in the future, particularly if the operations of our contract manufacturing partners, our critical single source component providers, or the facility we operate in Tijuana, Mexico in collaboration with Tacna, are more severely impacted by the pandemic and associated containment measures.

Components of Operating Results

Revenue

We generate our revenue primarily from the sale of products and services. In addition, we enter into console operating lease arrangements that contain lease and non-lease components. Revenue related to lease arrangements is allocated to the lease and non-lease elements based on their relative standalone selling price, with the lease component recorded in product revenue and the non-lease component recorded in service and other revenue.

Product Revenue

We generate product revenue from the sale, and to a lesser extent, leasing of our Tablo consoles and the sale of related consumables, including the Tablo cartridge. Revenue is recognized when control of our Tablo consoles is transferred, generally upon shipment, and excludes the value of the first-year service agreement, which is recognized as service and other revenue. Leases of Tablo consoles are considered operating leases and recognized as revenue over their lease term. Consumables, including the Tablo cartridge, are recognized primarily upon shipment. Our product revenue has been generated by direct sales to customers in the United States.

Service and Other Revenue

We generate service revenue primarily from service agreements for our Tablo consoles and other revenue from shipping and handling charged to customers. Under the service agreements, we provide maintenance, repair and training services, connectivity to our cloud infrastructure, including Tablo Hub, as well as software updates, for Tablo consoles. The service agreements are typically entered into for a one-year term. Revenue from the sale of service agreements, including the revenue associated with the first-year service, is recognized ratably over the service period.

Cost of Revenue

Cost of Product Revenue

Cost of product revenue primarily consists of finished goods, reserves for excess and obsolete inventories, manufacturing overhead and warranty costs. Manufacturing overhead costs include the cost of quality assurance, material procurement, depreciation expense for equipment, facilities and information technology. We currently partner with contract manufacturers to produce Tablo cartridges and some Tablo consoles. As described above, we have also invested in insourcing Tablo console manufacturing at a facility we recently established in Tijuana, Mexico, where we direct the manufacturing of Tablo consoles, as well as the associated warehousing and product distribution. Cost of product revenue in absolute dollars will increase as our sales volume increases.

Cost of Service and Other Revenue

Cost of service and other revenue primarily consists of personnel and material expenses related to our employees performing maintenance and support services, including salaries, benefits, stock-based compensation expense and related expenses such as employer taxes, materials and supplies and allocated costs including facilities and information technology. We anticipate that we will continue to invest in personnel to support the expansion of our Tablo fleet while also utilizing our cloud-based data system, as well as enhanced product performance, to lower the cost of service as a percentage of revenue. Cost of service and other revenue in absolute dollars will increase as our sales volume increases.

Gross Profit and Gross Margin

We calculate gross margin as gross profit divided by revenue. Our gross profit has been and will continue to be, affected by a variety of factors, including sales volume of Tablo consoles and related consumables, the success of our cost-reduction strategies, the cost of direct materials, labor and manufacturing overhead, the contribution of console leases and associated services, discounting practices, product yields and headcount. We expect our margin to increase over the long term to the extent we are successful in our ability to lower the costs associated with the production of the Tablo console and consumables, which depends on our ability to drive lower costs with our suppliers, increase our sales volume, and maintain or increase our average selling price, which will enable us to leverage our fixed costs. In addition, sales of our Tablo consumables carry a higher margin than sales of our Tablo consoles. We intend to use our design, engineering and manufacturing capabilities to further advance and improve the efficiency of our manufacturing processes, which, if successful, we believe will lower production costs and enable us to increase our gross margin. While we expect gross margin to increase over the long term, we also anticipate it will likely fluctuate from quarter to quarter.

Operating Expenses

Research and Development

Research and development expenses primarily consist of costs of developing hardware and software enhancements to improve Tablo performance and lower cost of product revenue, software update releases, yield improvement activities and platform extensions, as well as clinical affairs and related clinical studies. Other research and development costs include personnel and related costs, supplies, testing, contract and other outside service fees, depreciation expense and allocated costs including facilities and information technology. In 2020, we experienced a significant increase in our stock-based compensation expense as a result of the cumulative stock-based compensation expense we recorded for outstanding options with performance and market-based vesting conditions when the performance vesting condition was satisfied upon the closing of our IPO. We expect our stock-based compensation expense to decrease in 2021 as compared to 2020 and then continue to increase in future periods, due primarily to potential increases in the value of our common stock and as we issue additional stock-based awards under our equity incentive plan and employee stock purchase plan to attract and retain employees. We plan to continue to invest in our research and development efforts. As a percentage of revenue, we expect research and development expenses to vary over time, depending on the level and timing of new product development initiatives.

Sales and Marketing

Sales and marketing expenses primarily consist of personnel expenses including salaries, benefits, sales commissions, travel and stock-based compensation expense. Other sales and marketing expenses include marketing and promotional activities, including trade shows and market research, government affairs and costs of outside consultants. In 2020, we experienced a significant increase in our stock-based compensation expense as a result of the cumulative stock-based compensation expense we recorded for outstanding options with performance and market-based vesting conditions when the performance vesting condition was satisfied upon the closing of our IPO. We expect our stock-based compensation expense to decrease in 2021 as compared to 2020 and then continue to increase in future periods, due primarily to potential increases in the value of our common stock and as we issue additional stock-based awards under our equity incentive plan and employee stock purchase plan to attract and retain employees. Shipping and handling costs, as well as the associated personnel expenses, are included in sales and marketing expenses. As we continue to drive the expansion of Tablo, we expect to continue to invest in our sales and support teams, marketing, and shipping and handling costs. As a result, we expect sales and marketing expenses to increase in absolute dollars in future periods. As a percentage of revenue, however, we expect sales and marketing expenses to continue to decrease over the long-term primarily as and to the extent our revenue grows.

General and Administrative

General and administrative expenses primarily consist of personnel expenses, including salaries, benefits, bonuses, travel and stock-based compensation expense. Other general and administrative expenses include professional services fees, such as legal, audit and tax fees, insurance costs, costs of outside consultants, employee recruiting and training costs. Moreover, we expect to incur additional expenses associated with operating as a public company, including legal, accounting, insurance, exchange listing, SEC compliance and investor relations, and as we expand our headcount to support our growth. In 2020, we experienced a significant increase in our stock-based compensation expense as a result of the cumulative stock-based compensation expense we recorded for outstanding options with performance and market-based vesting conditions when the performance vesting condition was satisfied upon the closing of our IPO. We expect our stock-based compensation expense to decrease in 2021 as compared to 2020 and then continue to increase in future periods, due primarily to potential increases in the value of our common stock and as we issue additional stock-based awards under our equity incentive plan and employee stock purchase plan to attract and retain employees. As a result, we expect general and administrative expenses to increase in absolute dollars in future periods. As a percentage of revenue, we expect general and administrative expenses to decrease over the long-term primarily as, and to the extent, our revenue grows.

Interest Income and Other Income, Net

Interest income and other income, net, primarily consists of interest earned on our cash and cash equivalents and short-term investments.

Interest Expense

Interest expense consists of interest on our debt and amortization of associated debt discount. In June 2017, we entered into a senior, secured, delayed draw term facility (the Perceptive Term Loan Agreement) with Perceptive Credit Holdings, LP to borrow up to $40.0 million (the Perceptive Term Loan) as described in Note 7 to our audited financial statements included elsewhere in this Annual Report. We borrowed $30.0 million of the term loan on the closing date of the Perceptive Term Loan Agreement. In July 2020, we used $30.0 million of the proceeds from the SVB Term Loan to repay in full all amounts due under the Perceptive Term Loan Agreement and cash on hand to pay $1.2 million in early prepayment, accrued interest and exit fees.

Change in Fair Value of Redeemable Convertible Preferred Stock Warrant Liability

In connection with our prior credit agreements and the Perceptive Term Loan Agreement, we issued warrants to purchase shares of our Series A, Series B and Series C redeemable convertible preferred stock to the respective lenders. We classified these warrants as a liability on our balance sheets that were remeasured to fair value at each reporting date with the corresponding change in fair value recognized in our statements of operations. Upon the completion of our IPO, the redeemable convertible preferred stock warrant liability was reclassified to additional paid-in capital.

Loss on Extinguishment of Term Loan

Loss on extinguishment of term loan is related to the repayment of the Perceptive Term Loan in July 2020, which included early prepayment and exit fees.

Provision for Income Taxes

Provision for income taxes primarily consists of income taxes in certain states in which we conduct business. We have a full valuation allowance for deferred tax assets, including net operating loss carryforwards and tax credits related primarily to research and development.

Results of Operations

Comparison of the Years Ended December 31, 2020 and 2019:

The following table summarizes our results of operations for the years ended December 31, 2020 and 2019 (in thousands, except percentages):

Years Ended December 31, Change

Revenue:

Cost of revenue:

Gross margin (26 ) % (118 ) %

Operating expenses:

Loss on extinguishment of term loan (1,567 ) — (1,567 ) *

Provision for income taxes — 20 (20 ) *

* Not meaningful

Revenue

Product Revenue

Product revenue increased by $25.9 million, or 188%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to a $21.2 million increase in console revenue driven by new customer adoption, fleet expansion across existing customers, sales that we believe were attributable to COVID-19 driven demand, and increased console leasing revenue ($2.6 million). In addition, sales of Tablo consumables, including cartridges, for the year ended December 31, 2020 increased by $4.7 million given our larger console installed base as compared to the prior year period.

Service and Other Revenue

Service and other revenue increased by $9.0 million, or 677%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to services associated with our larger Tablo installed base, including leased consoles, as well as COVID-19 driven demand for services associated with leased consoles.

Cost of Revenue

Cost of Product Revenue

Cost of product revenue increased by $29.9 million, or 110%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. This increase was primarily due to higher console and consumable volume of $35.4 million, higher manufacturing overhead of $5.5 million, resulting primarily from our investments in our manufacturing facility in Tijuana, Mexico, and a $0.3 million increase in stock-based compensation expense. This was offset by an $11.3 million reduction in product costs.

Cost of Service and Other Revenue

Cost of service and other revenue increased by $0.2 million, or 4%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. This increase was primarily due to additional headcount costs in our service department, which were offset by higher absorption of these costs across our larger installed base.

Gross Profit and Gross Margin

Gross profit increased by $4.8 million, or 27%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The gross margin percentage improved by 92 percentage points for the year ended December 31, 2020 as compared to the year ended December 31, 2019, driven primarily by $18.3 million related to higher margin sales of our products and $7.6 million in higher service revenue as a result of our larger installed base, including leased consoles. This was offset by $15.9 million in increased costs as a result of selling more product and a $5.5 million increase in in higher manufacturing overhead, which was, in turn, driven by a $2.2 million investment in our new manufacturing facility in Tijuana, Mexico, a $1.0 million increase in allocated costs and a $0.8 million increase in compensation and personnel costs.

Research and Development

Research and development expenses increased by $5.5 million, or 24%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to a $6.1 million increase in compensation and personnel costs, which includes a $4.3 million increase in stock-based compensation expense, and a $0.3 million increase in materials and supplies. These increases were partially offset by a $0.9 million decrease in professional service and consultant service expenses.

Sales and Marketing

Sales and marketing expenses increased by $24.8 million, or 122% for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to a $22.4 million increase in compensation and personnel costs as a result of increased headcount, which includes a $4.3 million increase in stock-based compensation expense, and a $10.1 million increase in commission expense as a result of higher orders, a $0.9 million increase in supplies, materials and freight expenses related to increased activities in support of driving penetration of Tablo, a $0.9 million increase in facilities and other allocated costs and a $0.6 million increase in professional service and consultant service expenses.

General and Administrative

General and administrative expenses increased by $21.6 million, or 242%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. The increase was primarily due to a $17.2 million increase in compensation and personnel costs, which includes a $11.8 million increase in stock-based compensation expense, a $4.5 million increase in professional and consultant services associated with being a public company including legal, accounting, and secondary offering costs, and a $0.3 million increase in depreciation expense. The increases were partially offset by a $0.4 million decrease in facilities and other allocated costs.

Interest Income and Other Income, Net

Interest income and other income, net decreased by $2.0 million, or 79%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. This decrease was driven by lower interest rates and a lower average balance in money market funds and short-term investment securities during 2020.

Interest Expense

Interest expense decreased by $1.4 million, or 32%, for the year ended December 31, 2020 as compared to the year ended December 31, 2019. This decrease was primarily due to a lower debt discount amortization expense in the year ended December 31, 2020, the repayment of our Perceptive Term Loan in July 2020 and a lower interest rate under the SVB Term Loan.

Change in Fair Value of Redeemable Convertible Preferred Stock Warrant Liability

The change in the fair value of redeemable convertible preferred stock warrant liability was driven by the changes in assumptions used to value the warrant liability. Upon the closing of our IPO in September 2020, all shares of our outstanding redeemable convertible preferred stock warrants were either exercised into common stock or automatically converted into warrants to purchase common stock. Accordingly, we have ceased to incur the change in fair value of redeemable convertible preferred stock warrant liability as the entire redeemable convertible preferred stock warrant liability was reclassified to additional paid-in capital.

Loss on Extinguishment of Term Loan

The loss on extinguishment of term loan of $1.6 million was recognized for the repayment of the Perceptive Term Loan in July 2020, which included early prepayment and exit fees.

Comparison of Years Ended December 31, 2019 and 2018

The following table summarizes our results of operations for the years ended December 31, 2019 and 2018 (in thousands, except percentages):

Years Ended December 31, Change

Revenue:

Cost of revenue:

Operating expenses:

Provision for income taxes 20 25 (5 ) (20 )

* Not meaningful

Revenue

Product Revenue

Product revenue increased by $12.0 million, or 686%, for the year ended December 31, 2019, compared to the year ended December 31, 2018. The increase was primarily due to $10.0 million in higher Tablo console revenue, which was driven by new customer adoption and fleet expansion with existing customers, as well as $0.5 million in increased console leasing revenue and $1.0 million in increased sales of Tablo consumables, including cartridges, given our higher Tablo installed base.

Service and Other Revenue

Service and other revenue increased by $1.1 million, or 415%, for the year ended December 31, 2019, compared to the year ended December 31, 2018. The increase was primarily due to growth in service contracts as a result of a higher Tablo installed base, as well as services associated with leased consoles.

Cost of Revenue

Cost of Product Revenue

Cost of product revenue increased by $19.4 million, or 248%, for the year ended December 31, 2019, compared to the year ended December 31, 2018. This increase was primarily due to higher console and consumable volume of $30.1 million, which was offset by a $10.6 million reduction in product costs and expense associated with upgrading certain prior generation consoles.

Cost of Service and Other Revenue

Cost of service and other revenue increased by $5.4 million for the year ended December 31, 2019, compared to the year ended December 31, 2018. This increase was primarily due to field service-related expenses resulting from the full rollout of Tablo into the commercial market.

Gross Profit and Gross Margin

Gross profit decreased by $11.7 million, or 191%, for the year ended December 31, 2019, compared to the year ended December 31, 2018. Gross margin increased for the year ended December 31, 2019, compared to the year ended December 31, 2018 by 187 percentage points. The decline in gross profit was primarily attributable to selling more Tablo consoles and cartridges for less than cost, partially offset by the lower materials cost as a result of our cost reduction efforts.

Research and Development

Research and development expenses increased by $0.4 million, or 2%, for the year ended December 31, 2019, compared to the year ended December 31, 2018. This increase was primarily due to a $1.3 million increase in compensation and personnel costs as a result of increased research and development headcount, a $1.2 million increase in outside service fees to support research and development and a $0.6 million increase in facilities and other allocated costs. Partially offsetting this increase was a decline of $2.2 million in materials and supplies and a $0.6 million decrease in clinical-related and other costs resulting from the completion of development of Tablo in late 2018.

Sales and Marketing

Sales and marketing expenses increased by $9.0 million, or 80%, for the year ended December 31, 2019, compared to the year ended December 31, 2018. This increase was primarily due to a $5.0 million increase in compensation and personnel costs, including a $1.4 million increase in commission expense as a result of higher product revenue, a $1.6 million increase in promotional and travel expenses related to an increase in activities in support of driving penetration in the acute care market, a $1.2 million increase in facilities and other allocated costs and a $1.1 million increase in outside service fees related to the clinical adoption of our products.

General and Administrative

General and administrative expenses increased by $2.7 million, or 43%, for the year ended December 31, 2019, compared to the year ended December 31, 2018. This increase was primarily due to a $1.9 million increase in compensation and personnel costs as a result of increased headcount and a $0.7 million increase in outside consultant expenses and professional service expenses.

Interest Income and Other Income, Net

Interest income and other income, net increased by $0.8 million, or 45%, for the year ended December 31, 2019, compared to for the year ended December 31, 2018. This increase was primarily due to a higher average balance in money market funds and short-term investment securities during the year ended December 31, 2019.

Interest Expense

Interest expense decreased by $0.4 million, or 8%, for the year ended December 31, 2019, compared to the year ended December 31, 2018, primarily due to lower debt discount amortization expense for the year ended December 31, 2019.

Change in Fair Value of Redeemable Convertible Preferred Stock Warrant Liability

The change in fair value of the redeemable convertible preferred stock warrant liability increased by $4.1 million for the year ended December 31, 2019, compared to the year ended December 31, 2018, reflecting a decrease in the redeemable convertible preferred stock warrant liability that resulted from the amendment and restatement of our certificate of incorporation in September 2019.

Liquidity and Capital Resources

Sources of Liquidity

Since our inception, we have incurred net losses and negative cash flows from operations. To date, we have financed our operations and capital expenditures primarily through sales of redeemable convertible preferred stock and common stock, revenue from sales and issuances of debt. In September 2020, we completed our IPO for aggregate net proceeds of approximately $254.8 million (inclusive of the full exercise of the underwriters’ option to purchase additional shares), net of offering costs, underwriter discounts and commissions of approximately $23.1 million.

We expect to continue to incur significant expenses for the foreseeable future and to incur operating losses in the near term while we make investments to support our anticipated growth. We may raise additional capital through the issuance of additional equity financing, debt financings or other sources. If this financing is not available to us at adequate levels or on acceptable terms, we may need to reevaluate our operating plans. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our existing stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. We believe that our existing cash, cash equivalents and short-term investments, and cash generated from sales of our products, will be sufficient to meet our anticipated needs for at least the next 12 months from the date of this Annual Report.

Cash Flows Summary

The following table summarizes the cash flows for each of the periods indicated (in thousands):

Years Ended December 31,

Net cash (used in) provided by:

Net Cash Flows from Operating Activities

Net cash used in operating activities of $99.0 million for the year ended December 30, 2020 was due to a net loss of $121.5 million and a net cash outflow from the change in our operating assets and liabilities of $5.8 million, partially offset by non-cash adjustments for stock-based compensation expense of $21.4 million, depreciation and amortization of $3.2 million, loss on extinguishment of term loan of $1.6 million, non-cash interest expense of $0.6 million, non-cash lease expense of $0.6 million, provision for inventories of $0.5 million, loss on disposal of property and equipment of $0.2 million, and change in fair value of redeemable convertible preferred stock warrant liability of $0.1 million. The net cash outflow from operating assets and liabilities was primarily due to an increase in inventories of $16.3 million due to the timing of inventory purchases including advance purchases of inventory due to anticipated demand, an increase in prepaid expenses and other assets of $6.2 million, an increase in accounts receivable of $2.6 million due to timing of collections, and an increase in accrued interest of $0.2 million for the SVB Term Loan. The net cash outflow from operating assets and liabilities was partially offset by an increase in accrued payroll and related benefits of $9.9 million due to an increase in headcount, an increase in accrued expenses and other current liabilities of $4.8 million consistent with the growth of our business, an increase in deferred revenue of $2.8 million, an increase in accrued warranty liability of $1.2 million, an increase in accounts payable of $0.7 million due to timing of vendor payments, and an increase in operating lease liability of $0.1 million.

Net cash used in operating activities for the year ended December 31, 2019 was $70.3 million, attributable to a net loss of $68.3 million and a net cash outflow from the change in our operating assets and liabilities of $1.6 million and net non-cash adjustment of $0.4 million. Non-cash adjustments primarily consisted of $3.8 million in change in fair value of the redeemable convertible preferred stock warrant liability and $1.0 million in amortization of premium on investments, partially offset by $1.5 million in depreciation and amortization, $0.9 million in non-cash interest expense, $0.9 million in stock-based compensation expense, $0.5 million in non-cash lease expense, $0.3 million in loss on disposal of property and equipment and $0.3 million in provision for inventory. The net cash outflow from the change in our operating assets and liabilities was primarily due to a $5.0 million increase in inventory to support the growth in our business, a $2.9 million increase in accounts receivable due to higher revenue, a $0.2 million increase in prepaid expenses and other assets and a $0.5 million decrease in operating lease liability. These changes were partially offset by a $3.1 million increase in accrued payroll and related benefits due to higher headcount, a $1.8 million increase in accounts payable and accrued expenses and other current liabilities attributable to expansion in our operating activities and timing of payment, a $1.4 million increase in accrued warranty liability and a $0.7 million increase in deferred revenue mainly due to the growth of our business.

Net cash used in operating activities for the year ended December 31, 2018 was $46.4 million, attributable to a net loss of $49.8 million and a net cash outflow from the change in our operating assets and liabilities of $0.2 million, partially offset by non-cash adjustments of $3.6 million. Non-cash charges primarily consisted of $1.3 million amortization of deferred financing costs and fees, $1.1 million in depreciation, $0.4 million in provision for inventory and $0.4 million in non-cash lease expense, partially offset by $0.8 million in amortization of premium on investments. The change in our net operating assets and liabilities was primarily due to a $3.1 million increase in accounts payable and accrued expenses resulting primarily from expansion in our operating activities and timing of payment and a $0.6 million increase in accrued payroll and related benefits due to increased headcount. These changes were partially offset by a $2.2 million increase in inventories, a $0.6 million increase in accounts receivable due to higher revenue, a $0.5 million increase in prepaid expenses and other current assets, a $0.5 million decrease in operating lease liability, a $0.4 million decrease in accrued warranty liability and a $0.3 million increase in prepaid expenses and other assets.

Net Cash Flows from Investing Activities

Net cash used in investing activities of $3.9 million for the year ended December 31, 2020 was due primarily to purchases of short-term investments of $32.9 million and purchases of property and equipment of $9.1 million, partially offset by the sales and maturities of short-term investments of $45.9 million.

Net cash provided by investing activities for the year ended December 31, 2019 was $74.3 million and related to the sales and maturities of short-term investments of $169.5 million, partially offset by purchases of short-term investments of $91.9 million and purchases of property and equipment of $3.3 million.

Net cash used in investing activities for the year ended December 31, 2018 was $68.8 million and related to the purchases of short-term investments of $132.3 million and the purchases of property and equipment of $1.8 million, partially offset by sales and maturities of short-term investments of $65.3 million.

Net Cash Flows from Financing Activities

Net cash provided by financing activities of $385.7 million for the year ended December 31, 2020 was due primarily to the net proceeds of approximately $254.8 million from the issuance of our common stock in our IPO, net of issuance costs paid to date, the net proceeds of $126.8 million from the issuance of our Series E redeemable convertible preferred stock, the net proceeds of $29.6 million from borrowings on the SVB Loan and Security Agreement, proceeds of $4.3 million from the exercise of the Series C redeemable convertible preferred stock warrants, and proceeds of $1.2 million from the issuance of common stock from exercises of stock options, partially offset by the cash outflow of $31.0 million in repayment of the Perceptive Term Loan which included early prepayment and exit fees.

Net cash provided by financing activities for the year ended December 31, 2019 was $0.2 million and related to proceeds of $0.3 million from the exercise of stock options and $0.1 million from the exercise of a common stock warrant, partially offset by $0.2 million in paid issuance costs on our Series D redeemable convertible preferred stock issued in November 2018.

Net cash provided by financing activities for the year ended December 31, 2018 was $134.9 million and related primarily to net proceeds of $134.6 million from the issuance of our Series D redeemable convertible preferred stock and $0.3 million from the exercise of stock options.

Debt Obligations

SVB Loan and Security Agreement

We entered into a senior secured term loan facility with Silicon Valley Bank (SVB) in July 2020 (the SVB Loan and Security Agreement), which provides for a $30.0 million term loan (the SVB Term Loan). We used the SVB Term Loan proceeds to repay in full all amounts due under the Perceptive Term Loan and cash on hand to pay $1.2 million in early prepayment, accrued interest and exit fees.

There is also a final payment equal to 6.75% of the original principal amount of the SVB Term Loan, or approximately $2.0 million, due at maturity (or any earlier date of optional pre-payment or acceleration of principal due to an event of default). We may, at our option, prepay the SVB Term Loan in full, subject to an additional prepayment fee ranging between 1% and 3% of the outstanding principal amount of the SVB Term Loan. The prepayment fee would also be due and payable in the event of an acceleration of the principal amount of the supplemental term loan due to an event of default. The SVB Term Loan is secured by substantially all of our assets, including all of the capital stock held by us, if any (subject to a 65% limitation on pledges of capital stock of foreign subsidiaries), subject to certain exceptions.

In the event of default or change in control, all unpaid principal and all accrued and unpaid interest amounts (if any) become immediately due and payable including the prepayment fee. Events of default include, but are not limited to, a payment default, a material adverse change, and insolvency. The SVB Loan and Security Agreement contains customary representations, warranties, affirmative covenants and also contains certain restrictive covenants, including, among others, limitations on: the incurrence of additional debt, liens on property, acquisitions and investments, loans and guarantees, mergers, consolidations, liquidations and dissolutions, asset sales, dividends and other payments in respect of our capital stock, prepayments of certain debt, transactions with affiliates and changes to our type of business, management of the business, control of the business or business locations. We are also obligated to maintain a restricted cash balance greater or equal to the outstanding principal balance of $30.0 million of the SVB Term Loan.

Contractual Obligations and Commitments

The following table summarizes our contractual obligations and other commitments as of December 31, 2020:

Payments Due by Period

Less than 1 to 3 3 to 5 More than

1 Year Years Years 5 Years Total

(in thousands)

Off-Balance Sheet Arrangements

During the periods presented, we did not have, nor do we currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the SEC.

Critical Accounting Policies and Estimates

Management’s discussion and analysis of the financial condition and results of operations is based on the financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses incurred during the reporting periods. The estimates are based on historical experience and on various other factors that are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions and any such differences may be material.

While the significant accounting policies are more fully described in Note 2 to our audited financial statements included elsewhere in this Annual Report, we believe that the following critical accounting policies are most important to understanding and evaluating our reported financial results.

Revenue Recognition

We consider each product and each service contract to be a distinct performance obligation. Revenue is recognized when a performance obligation is satisfied, which occurs when control of the promised products or services is transferred to the customer in an amount that reflects the consideration we expect to receive in exchange for those products or services. Revenue from product sales is recognized at a point in time when management has determined that control has transferred to the customer, which is generally when legal title has transferred to the customer. Revenue from support and maintenance contracts is recognized as the output of the service is transferred to the customer over time, typically evenly over the contract term. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.

Our contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Judgment is also required to determine the stand-alone selling price (SSP) for each distinct performance obligation. We use an observable price to estimate SSP for items that are sold separately, including customer support agreements. In instances where SSP is not directly observable, such as when we do not sell the product or service separately, we determine the SSP using information that may include market conditions and other observable inputs. We may offer additional goods or services to customers at the inception of customer contracts at prices not at SSP. This is considered a material right and an additional performance obligation of the contract. SSP is assigned based on the estimated value of the material right.

Costs associated with product sales include commissions. We apply the practical expedient to expense the commissions as incurred as the expected amortization period is one year or less. Commissions are recorded as sales and marketing expenses in the statements of operations.

Stock-Based Compensation Expense

Our stock-based compensation expense relates to stock options with a service condition, stock options with performance and market-based vesting conditions, stock purchase rights under our Employee Stock Purchase Plan (ESPP), restricted stock units (RSUs) and performance stock units (PSUs). Stock-based compensation expense for our stock-based awards is based on their grant date fair value.

Service-based options initially granted to an optionee generally vest at a rate of 25% on the first anniversary of the original vesting date, with the balance vesting monthly over the remaining three years. Any subsequent follow-on options granted to the optionee generally vest monthly over four years. We estimate the fair value of stock options with a service condition and stock purchase rights under our ESPP on the grant date using the Black-Scholes option-pricing model. The fair value of these awards is recognized as compensation expense on a straight-line basis over the requisite service period in which the awards are expected to vest and forfeitures are recognized as they occur.

The Black-Scholes model considers several variables and assumptions in estimating the fair value of service-based stock options and stock purchase rights under our ESPP. These variables include the per share fair value of the underlying common stock, exercise price, expected term, risk-free interest rate, expected annual dividend yield and expected stock price volatility over the expected term. For all stock options granted, we calculate the expected term using the simplified method for “plain vanilla” stock option awards. We had no publicly available stock price information prior to our IPO and limited available stock price information subsequent to our IPO; therefore, we have used the historical volatility of the stock price of similar publicly traded peer companies. The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon issues similar in duration to the expected term of the equity-settled award.

For stock options with performance and market-based vesting conditions, stock-based compensation expense is recognized when it is considered probable that the performance vesting condition will be satisfied. Prior to our IPO in September 2020, we had not recognized any stock-based compensation expense as the satisfaction of the performance condition was not considered probable. Upon the closing of our IPO, we recorded a cumulative stock-based compensation expense using the accelerated attribution method as the performance condition was satisfied. Stock-based compensation expense related to these options is not reversed if the achievement of the market condition does not occur. The fair value of these stock options is estimated using the Monte Carlo approach.

RSUs initially granted to an optionee generally vest at a rate of 25% on the first anniversary of the original vesting date, with the balance vesting quarterly over the remaining three years. The fair value of RSUs is based on the market price of our common stock on the date of grant. The determination of fair value of performance stock units requires the use of certain estimates and assumptions that affect the amount of stock-based compensation expense recognized in our statements of operations. At each reported period, we reassess the probability of the achievement of corporate performance goals to estimate the number of shares to be released. Any increase or decrease in stock-based compensation expense resulting from an adjustment in the estimated shares to be released is treated as accumulative catch-up in the period of adjustment. If any of the assumptions or estimates used change significantly, stock-based compensation expense may differ materially from what we have recorded in the current period.

Inventories

Inventories are stated at the lower of cost or net realizable value. Cost is determined using the standard cost method, which approximates actual costs as determined on a first-in, first-out basis. The carrying value of inventories is reduced for any difference between cost and net realizable value of inventories that is determined to be obsolete or unmarketable, based upon assumptions about future demand and market conditions. We also review our inventory value to determine if it reflects the lower of cost or net realizable value based on factors such as inventory items sold at negative gross margins and non-cancellable purchase commitments. Adjustments to the value of inventory establish a new cost basis and are considered permanent even if circumstances later suggest that increased carrying amounts are recoverable. If demand is higher than expected, we may sell inventory that had previously been written down.

Common Stock Valuations

Prior to our IPO, there was no public market for our common stock. As such, the estimated fair value of our common stock and underlying stock options has been determined at each grant date by our board of directors, with input from management, based on the information known to us on the recent events and their potential impact on the estimated per share fair value of our common stock. As part of these fair value determinations, our board of directors obtained and considered valuation reports prepared by a third-party valuation firm in accordance with the guidance outlined in the American Institute of Certified Public Accountants Technical Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation.

For valuations after the completion of our IPO, the fair value of each share of underlying common stock is based on the closing price of our common stock as reported on the date of grant.

Redeemable Convertible Preferred Stock Warrant Liability

We accounted for our freestanding warrants to purchase shares of our redeemable convertible preferred stock prior to our IPO as liabilities at fair value upon issuance primarily because the shares underlying the warrants contained contingent redemption features outside of our control. The warrants were subject to re-measurement at each balance sheet date and any change in fair value was recognized in the statements of operations as the change in fair value of redeemable convertible preferred stock warrant liability. Upon the completion of our IPO, the liability on the redeemable convertible preferred stock warrants was reclassified to additional paid-in capital.

We estimated the fair value of these liabilities using the Black-Scholes option pricing model and assumptions that were based on the individual characteristics of the warrants on the valuation date, as well as assumptions for future financings, expected volatility, expected life, yield, and risk-free interest rate.

Emerging Growth Company Status

We are an emerging growth company, as defined in the JOBS Act. Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.

Recent Accounting Pronouncements

Refer to Note 2, “Summary of Significant Accounting Policies” in our audited financial statements included in Part II, Item 8 of this Annual Report for a discussion of recent accounting pronouncements that may impact us.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Interest Rate Risk

Our cash, cash equivalents, restricted cash and short-term investments as of December 31, 2020 consist of $348.2 million in bank deposits, money market funds, U.S. Treasury and debt securities. Such interest-earning instruments carry a degree of interest rate risk. The goals of our investment policy are liquidity and capital preservation; we do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate exposure. We believe that we do not have any material exposure to changes in the fair value of these assets as a result of changes in interest rates due to the short-term nature of our cash, cash equivalents and short-term investments.

As of December 31, 2020, we had $30.0 million in variable rate debt outstanding. The SVB Term Loan matures on November 1, 2025, with interest-only monthly payments until June 2023. The term loan accrues interest at a rate per annum equal to the greater of (A) one-half of one percent (0.50%) above the Prime Rate as reported in the Wall Street Journal then in effect (which shall not be less than zero) and (B) three and three-quarters of one percent (3.75%). An immediate 100 basis point change in the prime rate would not have a material impact on our debt-related obligations, financial position or results of operations.

Foreign Currency Exchange Risk

Our expenses are generally denominated in U.S. dollars. However, we have entered into a limited number of supply contracts with vendors with payments denominated in foreign currencies. We are subject to foreign currency transaction gains or losses on our contracts denominated in foreign currencies. To date, foreign currency transaction gains and losses have not been material to our financial statements.

Unfavorable changes in foreign exchange rates versus the U.S. dollar could increase our product costs, thus reducing our gross profit. We have not engaged in the hedging of foreign currency transactions to date, although we may choose to do so in the future. We do not believe that an immediate 10% increase or decrease in the relative value of the U.S. dollar to other currencies would have a material effect on operating results or financial condition.

Item 8. Financial Statements and Supplementary Data.

Outset Medical, Inc.

Index to Financial Statements

Page

Report of Independent Registered Public Accounting Firm 101

Balance Sheets 102

Statements of Operations 103

Statements of Comprehensive Loss 104

Statements of Cash Flows 106

Notes to Financial Statements 108

100

Report of Independent Registered Public Accounting Firm

To the Stockholders and Board of Directors

Outset Medical, Inc.:

Opinion on the Financial Statements

We have audited the accompanying balance sheets of Outset Medical, Inc. (the Company) as of December 31, 2020 and 2019, the related statements of operations, comprehensive loss, redeemable convertible preferred stock and stockholders’ equity (deficit), and cash flows for each of the years in the three-year period ended December 31, 2020, and the related notes (collectively, the financial statements). In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the years in the three-year period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.

Basis for Opinion

These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.

We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion.

Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.

/s/ KPMG LLP

We have served as the Company's auditor since 2011.

San Francisco, California

March 22, 2021

101

Outset Medical, Inc.

Balance Sheets

(in thousands, except per share amounts)

December 31,

Assets

Current assets:

Prepaid expenses and other current assets 6,189 1,058

Operating lease right-of-use assets 8,253 —

Current liabilities:

Accrued compensation and related benefits 16,845 6,956

Accrued expenses and other current liabilities 7,903 2,909

Operating lease liabilities, current 882 —

Term loan, current — 7,500

Accrued interest, noncurrent 240 217

Deferred revenue, noncurrent 570 134

Operating lease liabilities, noncurrent 8,044 —

Redeemable convertible preferred stock warrant liability — 4,285

Commitments and contingencies (Note 6)

Stockholders' equity (deficit):

Accumulated other comprehensive income 1 22

The accompanying notes are an integral part of these financial statements

102

Outset Medical, Inc.

Statements of Operations

(in thousands, except per share amounts)

Years Ended December 31,

Revenue:

Cost of revenue:

Operating expenses:

Loss on extinguishment of term loan (1,567 ) — —

Provision for income taxes — 20 25

Gain on extinguishment of redeemable convertible preferred stock — 117,598 —

Deemed dividend on settlement of accrued dividend 42,530 — —

The accompanying notes are an integral part of these financial statements

103

Outset Medical, Inc.

Statements of Comprehensive Loss

(in thousands)

Years Ended December 31,

Other comprehensive income (loss):

Unrealized gain (loss) on available-for-sale securities (21 ) 82 (37 )

The accompanying notes are an integral part of these financial statements

104

Outset Medical, Inc.

Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

(in thousands)

Shares Amount Shares Amount Capital Income (Loss) Deficit (Deficit)

Stock-based compensation expense — — — — 788 — — 788

Unrealized loss on available-for-sale securities — — — — — (37 ) — (37 )

Common stock warrant exercises — — 9 — 76 — — 76

Stock-based compensation expense — — — — 883 — — 883

Unrealized gain on available-for-sale securities — — — — — 82 — 82

Issuance of common stock for settlement of RSUs — — 5 — — — — —

Stock-based compensation expense — — — — 21,439 — — 21,439

Unrealized loss on available-for-sale securities — — — — — (21 ) — (21 )

The accompanying notes are an integral part of these financial statements

105

Outset Medical, Inc.

Statements of Cash Flows

(in thousands)

Years Ended December 31,

Cash flows from operating activities:

Adjustments to reconcile net loss to net cash used in operating activities:

Provision for accounts receivable 12 59 —

Loss on disposal of property and equipment 235 293 —

Loss on extinguishment of term loan 1,567 — —

Changes in operating assets and liabilities:

Prepaid expenses and other assets (6,245 ) (228 ) (270 )

Accrued expenses and other current liabilities 4,798 974 457

Accrued interest (217 ) — —

Operating lease liabilities 77 (505 ) (464 )

Cash flows from investing activities:

Purchases of property and equipment (9,108 ) (3,293 ) (1,766 )

Proceed from sales of property and equipment 31 — —

Net cash provided by (used in) investing activities 3,947 74,297 (68,776 )

Cash flows from financing activities:

Proceeds from issuance of term loan, net of issuance costs 29,630 — —

Repayment of term loan and extinguishment costs (30,985 ) — —

Repayment of finance lease (9 ) (9 ) (9 )

Proceeds from exercise of common stock warrant — 76 —

Payment of redeemable convertible preferred stock issuance costs — (181 ) —

Net increase in cash, cash equivalents and restricted cash 290,614 4,254 19,654

Supplemental cash flow disclosures:

Cash paid for income taxes $ 19 $ 35 $ 9

The accompanying notes are an integral part of these financial statements

106

Outset Medical, Inc.

Statements of Cash Flows

(in thousands)

Years Ended December 31,

Supplemental non-cash investing and financing activities:

Transfer of inventories to property and equipment $ 2,131 $ 3,119 $ —

Right-of-use assets obtained in exchange for lease liabilities $ 8,849 $ — $ —

Deemed dividend on settlement of accrued dividend $ 42,530 $ — $ —

Issuance of common stock on settlement of accrued dividend $ 41,763 $ — $ —

The accompanying notes are an integral part of these financial statements

107

Notes to Financial Statements

1. Description of Business

Outset Medical, Inc. (the Company) was originally incorporated on May 5, 2003 in the state of Delaware under the name Home Dialysis Plus, Ltd. The name of the Company was changed to Outset Medical, Inc. on January 5, 2015. Outset Medical, Inc. is a medical technology company pioneering a first-of-its-kind technology to reduce the cost and complexity of dialysis. The Tablo Hemodialysis System, FDA cleared for use from the hospital to the home, represents a significant technological advancement designed to transform the dialysis experience for patients and operationally simplify it for providers. Tablo serves as a single enterprise solution that designed to be utilized across the continuum of care, allowing dialysis to be delivered anytime, anywhere and by anyone. The integration of water purification and on-demand dialysate production enables Tablo to serve as a dialysis clinic on wheels, with 2-way wireless data transmission and a proprietary data analytics platform powering a new holistic approach to dialysis care. The Company’s headquarters are located in San Jose, CA.

The Company’s registration statement on Form S-1 related to its initial public offering (IPO) was declared effective by the Securities and Exchange Commission (SEC) on September 14, 2020, and the Company’s common stock began trading on the Nasdaq Global Select Market on September 15, 2020. Upon the completion of the IPO, the Company sold 10,294,000 shares of common stock (which included 1,343,000 shares that were sold pursuant to the full exercise of the underwriters’ option to purchase additional shares in connection with the IPO) at a price to the public of $27.00 per share. Including the full exercise of the underwriters’ option to purchase additional shares, the Company received aggregate net proceeds of approximately $254.8 million after deducting offering costs, underwriting discounts and commissions of approximately $23.1 million.

During the year ended December 31, 2020, the Company recognized $18.5 million of cumulative stock-based compensation expense associated with stock options that vest upon the achievement of market and performance conditions satisfied on the effectiveness of the IPO (see Note 9 for further discussion).

Reverse Stock Split

In September 2020, the Company’s board of directors and shareholders approved a certificate of amendment to the amended and restated certificate of incorporation to effect a reverse split of shares of the Company’s common stock on a 7.9-for-one basis (the Reverse Stock Split) effective as of September 8, 2020. The number of authorized shares and the par values of the common stock and redeemable convertible preferred stock were not adjusted as a result of the Reverse Stock Split. In connection with the Reverse Stock Split, the conversion ratio for the Company’s outstanding redeemable convertible preferred stock was proportionately adjusted such that the common stock issuable upon conversion of such preferred stock was decreased in proportion to the Reverse Stock Split. All references to common stock and options to purchase common stock, share data, per share data and related information contained in these financial statements and related notes have been retrospectively adjusted to reflect the effect of the Reverse Stock Split for all periods presented.

Liquidity

Since inception, the Company has incurred net losses and negative cash flows from operations. During the years ended December 31, 2020, 2019 and 2018, the Company incurred net losses of $121.5 million, $68.3 million and $49.8 million, respectively. As of December 31, 2020, the Company had an accumulated deficit of $494.1 million.

As of December 31, 2020, the Company had cash, cash equivalents and short-term investments of $314.9 million, which are available to fund future operations, and restricted cash of $33.3 million, for a total cash, cash equivalents, restricted cash and short-term investments balance of $348.2 million. Management expects to continue to incur significant expenses for the foreseeable future and to incur operating losses in the near term while the Company makes investments to support its anticipated growth. Management believes that the Company’s existing cash, cash equivalents and short-term investments, which include the proceeds from the IPO, and cash generated from revenues from its products, as well as services and other sales, will be sufficient to meet its anticipated needs for at least the next 12 months from the issuance date of the financial statements.

2. Summary of Significant Accounting Policies

Basis of Presentation

The financial statements have been prepared in accordance with U.S. generally accepted accounting principles (U.S. GAAP). All share amounts disclosed in the notes to the financial statements are rounded to the nearest thousand except for per share amounts.

108

Use of Estimates

The preparation of the financial statements in conformity with U.S. GAAP requires management to make judgments, estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities as of the date of the financial statements and the reported amounts of revenue and expenses. These judgments, estimates and assumptions are used for, but not limited to, revenue recognition, allowance for doubtful accounts, inventory valuation and write-downs, warranty obligations, the fair value of common stock and redeemable convertible preferred stock, the fair value of stock options, the fair value of the redeemable convertible preferred stock warrant liability, valuation of investments, recoverability of the Company’s net deferred tax assets and the related valuation allowance, and certain accrued expenses. The Company evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors and adjusts those estimates and assumptions when facts and circumstances dictate. Actual results may differ from those estimates under different assumptions or conditions and the differences may be material.

Segment

The Company operates as a single operating segment. The Company’s chief operating decision maker, its Chief Executive Officer, reviews financial information on an aggregate basis for the purposes of allocating resources and evaluating financial performance. The Company’s primary operation is in the United States and it has derived its revenue from sales to customers in the United States. The Company has operated a manufacturing facility in Mexico since 2020. The Company's long-lived tangible assets, as well as the Company's operating lease right-of-use assets recognized on the balance sheets, located in Mexico were $6.0 million as of December 31, 2020.

Cash, Cash Equivalents and Restricted Cash

As of December 31, 2020, the restricted cash balance of $33.3 million primarily relates to contractual obligations under the SVB Loan and Security Agreement (see Note 7) and collateral for the building leases in San Jose, CA and Tijuana, Mexico. The restricted cash balance of $0.7 million as of December 31, 2019 relates to collateral for the building leases.

The Company considers all highly liquid investments purchased with an original maturity of three months or less at the date of purchase to be cash equivalents. As of December 31, 2020 and 2019, the Company’s cash equivalents were held in institutions in the United States and include deposits in a money market fund which were unrestricted as to withdrawal or use.

The following table provides a reconciliation of cash, cash equivalents and restricted cash that sum to the total of the amounts shown in the statements of cash flows (in thousands):

December 31,

Total cash, cash equivalents and restricted cash $ 328,283 $ 37,669

Short-Term Investments

Short-term investments have been classified as available-for-sale and are carried at estimated fair value as determined based upon quoted market prices or pricing models for similar securities. The Company determines the appropriate classification of its investments in debt securities at the time of purchase. Available-for-sale securities with original maturities beyond three months at the date of purchase are classified as current based on their availability for use in current operations.

The Company’s investment securities are recorded at fair value based on the fair value hierarchy. Money market funds and U.S. Treasury securities are classified within Level 1 of the fair value hierarchy. Commercial paper, corporate debt and asset-backed securities are within Level 2 of the fair value hierarchy. Unrealized gains and losses, deemed temporary in nature, are reported as a separate component of accumulated other comprehensive income (loss).

A decline in the fair value of any security below cost that is deemed other than temporary results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Premiums (discounts) are amortized (accreted) over the life of the related security as an adjustment to yield using the straight-line interest method. Dividend and interest income are recognized when earned. Realized gains and losses are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

109

Concentration of Credit Risk

Financial instruments that potentially subject the Company to a concentration of credit risk consist of cash and cash equivalents, restricted cash, short-term investments and accounts receivable. Substantially all the Company’s cash and cash equivalents, restricted cash and investments are held at one financial institution in the United States that management believes is of high credit quality. Such deposits may, at times, exceed federally insured limits or may not be covered by deposit insurance at all. The Company has not experienced any credit losses on its cash and cash equivalents, restricted cash or short-term investments through December 31, 2020.

For the year ended December 31, 2020, three customers accounted for 22%, 19% and 16% of revenues, respectively. One customer accounted for 11% of revenues for the year ended December 31, 2019. Accounts receivable are unsecured and the Company does not require collateral; however, the Company does assess the collectability of accounts receivable based on a number of factors, including past transaction history with, and the creditworthiness of, the customer. Accordingly, the Company is exposed to credit risk associated with accounts receivable. Two customers accounted for 22% and 16% of accounts receivable, respectively, as of December 31, 2020. Four customers accounted for 22%, 13%, 11% and 10% of accounts receivable, respectively, as of December 31, 2019. To reduce risk, the Company closely monitors the amounts due from its customers and assesses the financial strength of its customers through a variety of methods that include, but are not limited to, engaging directly with customer operations and leadership personnel, visiting customer locations to observe operating activities, and assessing customer longevity and reputation in the marketplace. As a result, the Company believes that its accounts receivable credit risk exposure is limited.

Fair Value of Financial Instruments

The Company determines the fair value of an asset or liability based on the assumptions that market participants would use in pricing the asset or liability in an orderly transaction between market participants at the measurement date. The identification of market participant assumptions provides a basis for determining what inputs are to be used for pricing each asset or liability.

A fair value hierarchy has been established which gives precedence to fair value measurements calculated using observable inputs over those using unobservable inputs. This hierarchy prioritized the inputs into three broad levels as follows:

Level 1: Quoted prices in active markets for identical instruments;

Level 2: Other significant observable inputs (including quoted prices in active markets for similar instruments); and

Level 3: Significant unobservable inputs (including assumptions in determining the fair value of certain investments).

The Company’s cash and cash equivalents, restricted cash, short-term investments, accounts receivable, accounts payable and accrued liabilities approximate their fair value due to their short maturities. Management believes that its term loan bears interest at the prevailing market rates for instruments with similar characteristics; accordingly, the carrying value of this instrument approximates its fair value. Money market funds are highly liquid investments and are actively traded. The pricing information on the Company’s money market funds are readily available and can be independently validated as of the measurement date. This approach results in the classification of these securities as Level 1 of the fair value hierarchy.

The Company has issued redeemable convertible preferred stock warrants and estimated the fair value of these warrants using the Black-Scholes option pricing model, which is considered to be a Level 3 fair value measurement. The assumptions were based on the individual characteristics of the warrants on the valuation date, as well as assumptions for future financings, expected volatility, expected life, yield, and risk-free interest rate. Effective on the date of the IPO, the redeemable convertible preferred stock warrants were considered to be indexed to the Company’s stock, and accordingly, the fair value of redeemable convertible preferred stock warrant liability was remeasured immediately prior to the IPO (See Note 4).

Accounts Receivable, Net

Accounts receivable are recorded at invoice value, net of any allowance for doubtful accounts. Estimates of the allowance for doubtful accounts are determined based on existing contractual payment terms, historical payment patterns of customers and individual customer circumstances. The allowance for doubtful accounts was not significant as of December 31, 2020 and 2019, respectively.

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Inventories

Inventories are stated at the lower of cost or net realizable value. Cost is determined using the standard cost method, which approximates actual costs as determined on a first-in, first-out basis. The carrying value of inventories is reduced for any difference between cost and net realizable value of inventories that is determined to be obsolete or unmarketable, based upon assumptions about future demand and market conditions. The Company also reviews its inventory value to determine if it reflects the lower of cost or net realizable value based on factors such as inventory items sold at negative gross margins and purchase commitments. Adjustments to the value of inventory establish a new cost basis and are considered permanent even if circumstances later suggest that increased carrying amounts are recoverable. If demand is higher than expected, the Company may sell inventory that had previously been written down. Costs associated with the write-down of inventory are recorded to cost of revenue on the Company’s statements of operations.

Property and Equipment, Net

Property and equipment, net is stated at cost, net of accumulated depreciation. Depreciation is generally computed using the straight-line method based on the estimated useful lives of the assets, which is generally two to five years. Certain Tablo consoles under operating leases are depreciated using the accelerated method. Leasehold improvements are amortized using the straight-line method over the shorter of the assets estimated useful lives or the remaining term of the lease. Maintenance and repairs are charged to expense as incurred. Significant improvements that substantially enhance the useful life of an asset are capitalized and depreciated. When assets are retired or disposed of, the cost together with related accumulated depreciation is removed from the balance sheet and any resulting gain or loss is reflected in the Company’s statements of operations in the period realized.

Impairment for Long-Lived Assets

Long-lived assets, such as property and equipment are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group to be tested for possible impairment, the Company first compares undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, an impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary. There were no such impairment losses as of December 31, 2020 and 2019.

Leases

The Company determines if an arrangement is a lease at inception by assessing whether the arrangement contains an identified asset and whether it has the right to control the identified asset. Right-of-use (ROU) assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Lease liabilities are recognized at the lease commencement date based on the present value of future lease payments over the lease term. ROU assets are based on the measurement of the lease liability and also include any lease payments made prior to or on lease commencement and exclude lease incentives and initial direct costs incurred, as applicable.

As the implicit rate in the Company’s leases is generally unknown, the Company uses its incremental borrowing rate based on the information available at the commencement date in determining the present value of lease payments. The lease terms may include options to extend or terminate the lease when the Company is reasonably certain it will exercise such options. Lease costs for the Company’s operating leases are recognized on a straight-line basis over the reasonably assured lease term. Variable lease payments include lease operating expenses.

The Company has elected to not separate lease and non-lease components for any leases within its existing classes of assets and, as a result, accounts for any lease and non-lease components as a single lease component. The Company has also elected to not apply the recognition requirement to any leases within its existing classes of assets with a term of 12 months or less and does not include an option to purchase the underlying asset that the Company is reasonably certain to exercise.

Accrued Warranty Liability

The Company generally provides a one-year warranty for defective parts and workmanship on its Tablo consoles, commencing upon the transfer of title and risk of loss to the customer. The Company accrues the estimated cost of product warranties when it invoices the customer, based on historical experience and expected results. Should actual product failure rates and material usage costs differ from these estimates, revisions to the estimated warranty liability would be required. The Company periodically assesses the adequacy of its recorded product warranty liabilities and adjusts the balance as required. Warranty expense is recorded as a component of cost of product revenue in the statements of operations.

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Contract Liabilities - Deferred Revenue

The timing of revenue recognition may differ from the timing of invoicing to customers. The Company records deferred revenue when revenue is recognized subsequent to invoicing. For multi-year service agreements, the Company generally invoices customers annually at the beginning of each annual coverage period. Deferred revenue that will be recognized during the 12 months following the balance sheet date is recorded as the current portion of deferred revenue and the remaining portion is recorded as noncurrent.

Redeemable Convertible Preferred Stock Warrant Liability

The Company has accounted for its freestanding warrants to purchase shares of the Company’s redeemable convertible preferred stock as liabilities at fair value upon issuance primarily because the shares underlying the warrants contained contingent redemption features outside of the Company’s control. The warrants were subject to re-measurement at each balance sheet date and any change in fair value was recognized in the statements of operations as the change in fair value of redeemable convertible preferred stock warrant liability. The carrying value of the warrants would continue to be adjusted until these instruments are exercised, expire or convert into warrants to purchase shares of the Company’s common stock upon the completion of a liquidation event, including the completion of the IPO, which occurred on September 15, 2020. Upon the closing of the IPO, the liabilities were reclassified to additional paid-in capital, a component of Stockholders’ equity (deficit).

The Company estimated the fair value of these liabilities using the Black-Scholes option pricing model and assumptions that were based on the individual characteristics of the warrants on the valuation date, as well as assumptions for future financings, expected volatility, expected life, yield, and risk-free interest rate.

Defined Contribution Plan

The Company has a defined contribution retirement savings plan under Section 401(k) of the Internal Revenue Code. This plan allows eligible employees to defer a portion of their annual compensation on a pre-tax basis. The Company is authorized to make matching contributions but has not made such contributions for the years ended December 31, 2020, 2019 and 2018.

Revenue

The Company’s revenue is generated primarily from the sale of its products and services. Product revenue consists primarily of sales of the Tablo console and related consumables, including Tablo cartridges, used in treatment delivery. Service and other revenue consists primarily of revenue generated from consoles service contracts and other revenue from shipping and handling charged to customers.

The Company considers each product and each service contract to be a distinct performance obligation. Revenue is recognized when a performance obligation is satisfied, which occurs when control of the promised products or services is transferred to the customer in an amount that reflects the consideration the Company expects to receive in exchange for those products or services. Revenue from product sales is recognized at a point in time when management has determined that control has transferred to the customer, which is generally when legal title has transferred to the customer. Revenue from service contracts is recognized as the output of the service is transferred to the customer over time, typically evenly over the contract term. Revenue is recognized net of allowances for returns and any taxes collected from customers, which are subsequently remitted to governmental authorities.

The Company’s contracts with customers often include promises to transfer multiple products and services to a customer. Determining whether products and services are considered distinct performance obligations that should be accounted for separately versus together may require significant judgment. Judgment is also required to determine the stand-alone selling price (SSP) for each distinct performance obligation. The Company uses an observable price to estimate SSP for items that are sold separately, including customer support agreements. In instances where SSP is not directly observable, such as when the Company does not sell the product or service separately, the Company determines the SSP using information that may include market conditions and other observable inputs. The Company may offer additional goods or services to customers at the inception of customer contracts at prices not at SSP. This is considered a material right and an additional performance obligation of the contract. SSP is assigned based on the estimated value of the material right.

Costs associated with product sales include commissions. The Company applies the practical expedient to expense the commissions as incurred as the expected amortization period is one year or less. Commissions are recorded as sales and marketing expenses in thestatements of operations.

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Operating Lease Arrangements

The Company enters into operating lease arrangements that contain both lease and non-lease elements. The lease element includes Tablo consoles, while non-lease elements include consumables, services and training. Revenue related to such arrangements is allocated to lease and non-lease elements based on their relative SSP. Revenue for the lease element, net of any taxes collected from customers, is recognized on a straight-line basis as product revenue over the lease term, generally three months to one year, in the statements of operations. The costs of the leased Tablo consoles are included in property and equipment, net in the balance sheets and amortized to cost of product revenue.

Shipping and Handling Costs

Shipping and handling charged to customers are recorded as revenue. Shipping and handling costs are expensed as incurred and are included in sales and marketing expenses.

Stock-Based Compensation Expense

Stock-based compensation expense relates to stock options with a service condition, stock options with performance and market-based vesting conditions, stock purchase rights under our Employee Stock Purchase Plan (ESPP), restricted stock units (RSUs) and performance stock units (PSUs). Stock-based compensation expense for the Company’s stock-based awards is based on their grant date fair value.

Service-based options initially granted to an optionee generally vest at a rate of 25% on the first anniversary of the original vesting date, with the balance vesting monthly over the remaining three years. Any subsequent follow-on options granted to the optionee generally vest monthly over four years. The fair value of stock options with a service condition and stock purchase rights under the ESPP on the grant date is estimated using the Black-Scholes option-pricing model. The fair value of these awards is recognized as compensation expense on a straight-line basis over the requisite service period in which the awards are expected to vest and forfeitures are recognized as they occur.

The Black-Scholes model considers several variables and assumptions in estimating the fair value of service-based stock options and stock purchase rights under the ESPP. These variables include the per share fair value of the underlying common stock, exercise price, expected term, risk-free interest rate, expected annual dividend yield and expected stock price volatility over the expected term. For all service-based stock options granted, the Company calculates the expected term using the simplified method for “plain vanilla” stock option awards. The Company had no publicly available stock price information prior to the IPO and limited available stock price information subsequent to the IPO; therefore, the Company has used the historical volatility of the stock price of similar publicly traded peer companies. The risk-free interest rate is based on the yield available on U.S. Treasury zero-coupon issues similar in duration to the expected term of the equity-settled award.

For stock options with performance and market-based vesting conditions, stock-based compensation expense is recognized when it is considered probably that the performance vesting condition will be satisfied. Prior to the IPO in September 2020, the Company had not recognized any stock-based compensation expense as the satisfaction of the performance condition was not considered probable. Upon the closing of the IPO, the Company recorded a cumulative stock-based compensation expense using the accelerated attribution method as the performance condition was satisfied. Stock-based compensation expense related to these options is not reversed if the achievement of the market condition does not occur. The fair value of these stock options is estimated using the Monte Carlo approach.

RSUs initially granted to an optionee generally vest at a rate of 25% on the first anniversary of the original vesting date, with the balance vesting quarterly over the remaining three years. The fair value of RSUs and PSUs is based on the market price of the Company’s common stock on the date of grant. The determination of the stock-based compensation expense related to PSUs to be recognized in the Company’s statements of operations requires the use of certain estimates and assumptions. At each reported period, the Company reassesses the probability of the achievement of corporate performance goals to estimate the number of shares to be released. Any increase or decrease in stock-based compensation expense resulting from an adjustment in the estimated shares to be released is treated as accumulative catch-up in the period of adjustment. If any of the assumptions or estimates used change significantly, stock-based compensation expense may differ materially from what the Company has recorded in the current period.

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Research and Development

The Company expenses all research and development costs as incurred. These expenses include the costs of proprietary research and development efforts, quality engineering, clinical studies and trials and regulatory affairs. Costs include personnel and related costs, supplies, testing, contract and other outside service fees, depreciation expense and allocated costs including facilities and information technology.

Advertising Costs

Advertising costs are expensed as incurred. The advertising costs for years ended December 31, 2020, 2019 and 2018 were not significant.

Income Taxes

The Company accounts for income taxes under the asset and liability method. Under this method, deferred tax assets and liabilities are determined based on differences between financial reporting and tax reporting bases of assets and liabilities and remeasured using enacted tax rates and laws that are expected to be in effect when the differences are expected to reverse. Realization of deferred tax assets is dependent upon future earnings, the timing and amount of which are uncertain.

The Company utilizes a two-step approach to recognize and measure uncertain tax positions. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained upon tax authority examination, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon ultimate settlement.

The Company includes any penalties and interest expense related to income taxes as a component of other expense, net, as necessary.

Net Loss per Share Attributable to Common Stockholders

Basic net loss per share attributable to common stockholders is calculated by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding for the period, without consideration for potential dilutive securities.

Diluted net loss per share is computed by dividing the net loss by the weighted-average number of common shares and common share equivalents of potentially dilutive securities outstanding for the period. For purposes of the diluted net loss per share calculation, redeemable convertible preferred stock, awards under the Company’s equity compensation plan and warrants are considered to be potentially dilutive securities. For periods in which the Company reports net losses, basic net loss per share attributable to common stockholders is the same as diluted net loss per share attributable to common stockholders because the effects of potentially dilutive securities are antidilutive.

Recently Adopted Accounting Pronouncements

In August 2018, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement (ASU 2018-13). The amendments on changes in unrealized gains and losses recognized in other comprehensive income categorized within Level 3, the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and the narrative description of measurement uncertainty should be applied prospectively in the initial fiscal year of adoption. All other amendments should be applied retrospectively to all periods presented upon their effective date. The Company adopted ASU 2018-13 as of January 1, 2020, which did not have a material impact on its financial statements.

Recently Issued Accounting Pronouncements Not Yet Adopted

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326) Measurement of Credit Losses on Financial Instruments (ASU 2016-13), which requires an entity to utilize a new impairment model known as the current expected credit loss (CECL) model to estimate its lifetime “expected credit loss” and record an allowance that, when deducted from the amortized cost basis of the financial assets and certain other instruments, including but not limited to available-for-sale debt securities. Credit losses relating to available-for-sale debt securities will be recorded through an allowance for credit losses rather than as a direct write-down to the security. ASU 2016-13 requires a cumulative effect adjustment to the balance sheet as of the beginning

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of the first reporting period in which the guidance is effective. In November 2019, the FASB issued ASU 2019-10, Financial Instruments—Credit Losses (Topic 326), Derivatives and Hedging (Topic 815) and Leases (Topic 842): Effective Dates, which defers the effective date of ASU 2016-13 to fiscal years beginning after December 15, 2022 for all entities except SEC reporting companies that are not smaller reporting companies. ASU 2016-13 will be effective for the Company beginning January 1, 2023. The Company is currently evaluating the impact of the adoption of ASU 2016-13 on its financial statements.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740), which simplifies the accounting for income taxes, primarily by eliminating certain exceptions to ASC 740. This standard is effective for fiscal periods beginning after December 15, 2021. The Company is currently evaluating this standard and the impact it may have on its financial statements.

3. Revenue from Contracts with Customers

Disaggregation of Revenue

Revenue by source consisted of the following (in thousands):

Years Ended December 31,

For the years ended December 31, 2020 and 2019, $3.1 million and $0.5 million of consoles revenue were from console operating lease arrangements. There was no such lease revenue for the year ended December 31, 2018.

The maturity of the Company’s operating leases as of December 31, 2020 was as follows (in thousands):

Years Ending December 31:

Total minimum lease payments 6,130

Performance Obligations

As of December 31, 2020, the aggregate amount of the transaction price allocated to the remaining performance obligations related to customer service contracts that are unsatisfied or partially unsatisfied was $3.8 million, which is recorded as deferred revenue on the Company’s balance sheet. Of that amount, $3.2 million will be recognized as revenue during the year ended December 31, 2021 and approximately $0.6 million thereafter.

Contract Liabilities

The contract liabilities consist of deferred revenue which represents payments received in advance of revenue recognition related to console service agreements and for prepayments for products or services yet to be delivered. Revenue under these agreements is recognized over the related service period. The following table summarizes the Company’s contract liabilities (in thousands):

December 31,

Deferred revenue, current $ 3,201 $ 883

Deferred revenue, noncurrent 570 134

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During the year ended December 31, 2020, 2019 and 2018, the Company recognized $0.9 million, $0.3 million, and $0.3 million of revenue, respectively, that was included in the deferred revenue balance at the beginning of the period.

4. Fair Value Measurements

The following tables summarize the Company’s financial assets and liabilities measured at fair value on a recurring basis by level within the fair value hierarchy (in thousands):

Assets:

Cash equivalents:

Short-term investments:

Assets:

Cash equivalents:

Short-term investments:

Liabilities:

Total liabilities $ 4,285 $ — $ — $ 4,285

The Company’s Level 2 securities are valued using third-party pricing sources. The pricing services utilize industry standard valuation models, including both income and market-based approaches, for which all significant inputs are observable, either directly or indirectly, to estimate fair value. These inputs include reported trades of and broker/dealer quotes on the same or similar securities, issuer credit spreads, benchmark securities, prepayment/default projections based on historical data and other observable inputs. The Company validates the prices provided by its third-party pricing services by understanding the models used, obtaining market values from other pricing sources and confirming those securities traded in active markets.

As of December 31, 2020, the remaining contractual maturities for available-for-sale securities were less than one year.

Impairment assessments are made at the individual security level each reporting period. When the fair value of an available-for-sale security is less than its cost at the balance sheet date, a determination is made as to whether the impairment is other-than-temporary and, if it is other-than-temporary, an impairment loss is recognized in earnings equal to the difference between the investment’s amortized cost and fair value at such date. As of December 31, 2020 and December 31, 2019, none of the Company’s available-for-sale securities were in an unrealized loss position.

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Redeemable Convertible Preferred Stock Warrant Liability

The valuation of the Company’s redeemable convertible preferred stock warrant liability contained unobservable inputs that reflected the Company’s own assumptions for which there was little, if any, market activity at the measurement date. Accordingly, the Company’s redeemable convertible preferred stock warrant liability was measured at fair value on a recurring basis using unobservable inputs and were classified as Level 3 inputs, and any change in fair value of the redeemable convertible preferred stock warrant liability was recognized in the statements of operations.

Effective on the date of the IPO, the redeemable convertible preferred stock warrants were considered to be indexed to the Company’s stock and now meet the criteria to be classified in equity. The Company remeasured the warrants immediately prior to the IPO. The fair value of the Series A redeemable convertible preferred stock warrants which were converted into common stock warrants was determined using the Black-Scholes option-pricing model and deemed a Level 3 fair value measurement. The fair value of Series B and C redeemable convertible preferred stock warrants which were exercised was determined using the intrinsic method based on the IPO price of $27.00 per share and deemed a Level 2 fair value measurement. Subsequently, the entire redeemable convertible preferred stock warrants liability was reclassified to additional paid-in capital.

The fair value of the warrants, prior to the IPO, was determined using the Black-Scholes option pricing model and the following assumptions:

Years Ended December 31,

Dividend yield 0% 0% 0%

The change in fair value of the redeemable convertible preferred stock warrant liability was as follows (in thousands):

Years Ended December 31,

Reclassified to additional paid-in capital (3,126 ) — —

5. Balance Sheet Components

Inventories

Inventories consist of the following (in thousands):

December 31,

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Property and Equipment, net

Property and equipment, net consisted of the following (in thousands):

December 31,

Tablos under operating leases 5,158 3,120

Less: accumulated depreciation and amortization (4,988 ) (2,670 )

Total depreciation and amortization expense for the years ended December 31, 2020, 2019 and 2018 was $3.2 million, $1.5 million and $1.1 million, respectively.

Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following (in thousands):

December 31,

Accrued research and development expenses 175 421

Accrued professional services 2,187 553

Total accrued expenses and other current liabilities $ 7,903 $ 2,909

Accrued Warranty Liability

The change in accrued warranty liability is presented in the following table (in thousands):

December 31,

Balance at the beginning of the period $ 1,702 $ 293

Additions charge to cost of product revenue 4,858 2,578

Balance at the end of the period $ 2,913 $ 1,702

6. Commitments and Contingencies

Leases

In September 2019, the Company entered into an operating lease agreement for its new facility and office space in San Jose, CA that commenced in April 2020 and expires in March 2027. This operating lease contains a free rent period and an escalation clause. The landlord provided the Company with a tenant improvement allowance of up to $2.0 million. The Company issued an irrevocable standby letter of credit in the amount of $0.3 million in lieu of a cash security deposit. The letter of credit is fully secured by cash held at the bank in a restricted account.

In May 2020, the Company entered into an operating lease agreement for its new manufacturing facility in Tijuana, Mexico that commenced in May 2020 and will expire in August 2026. The Company took initial possession of the building with 48,437 square feet in May 2020 and will take possession of the second space with 38,750 square feet in June 2021. This operating lease contains a free rent period and an escalation clause. The Company issued an irrevocable standby letter of credit in the amount of $3.0 million, in lieu of a cash security deposit. The letter of credit is fully secured by cash held at the bank in a restricted account.

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Both leases include renewal options at the election of the Company to renew or extend the lease. The Company evaluatesrenewal options at lease inception and on an ongoing basis and includes renewal options that it is reasonably certain to exercise in its expected lease terms when classifying leases and measuring lease liabilities.

The Company also had a finance lease for office equipment that expired in 2020.

The following table presents the Company’s ROU assets and lease liabilities (in thousands):

December 31,

Lease Classification Balance Sheet Classification 2020 2019

Assets:

Operating Operating lease right-of-use assets $ 8,253 $ —

Finance Property and equipment ― 6

Total ROU assets $ 8,253 $ 6

Liabilities:

Current:

Operating Operating lease liabilities, current $ 882 $ —

Finance Accrued expense and other current liabilities ― 9

Noncurrent:

Operating Operating lease liabilities, noncurrent 8,044 ―

Total lease liabilities $ 8,926 $ 9

The components of lease costs were as follows (in thousands):

Years ended December 31,

Finance lease costs:

Amortization of right-of-use assets $ 6 $ 13 $ 10

Interest on lease liabilities — 1 1

Short-term lease costs 371 520 —

The weighted-average remaining lease term and discount rate were as follows:

December 31,

Operating leases:

Weighted-average remaining lease term 6.3 years ―

Weighted-average discount rate 8.7 % ―

Finance lease:

Weighted-average remaining lease term ― 0.5 years

Weighted-average discount rate ― 10.6 %

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The maturity of the Company’s operating lease liabilities as of December 31, 2020 were as follows (in thousands):

Years Ending December 31:

Total lease payments $ 11,674

Less: imputed interest (2,748 )

Present value of operating lease liabilities $ 8,926

Operating lease liabilities, current $ 882

Operating lease liabilities, noncurrent $ 8,044

Purchase Commitments

As of December 31, 2020, the Company had obligations under non-cancellable purchase commitments totaling $46.5 million, all of which will require payment within the next 12 months.

Litigation

From time to time, the Company may be involved in legal proceedings or investigations our reputation, business and financial condition and divert the attention of our management from the operation of our business. The Company is not presently a party to any legal proceedings that, if determined adversely to us, would individually or taken together have a material adverse effect on our business, results of operations, financial condition or cash flows.

Indemnifications

In the ordinary course of business, the Company often includes standard indemnification provisions its arrangements with its partners, customer and suppliers. Pursuant to these provisions, the Company may be obligated to indemnify such parties for losses or claims suffered or incurred in connection with its service, breach of representations or covenants, intellectual property infringement or other claims made against such parties. These provisions may limit the time within which an indemnification claim can be made. It is not possible to determine the maximum potential amount under these indemnification obligations due to the limited history of prior indemnification claims and the unique facts and circumstances involved in each particular agreement. To date, the Company has not incurred any material costs as a result of such indemnification obligations and has not accrued any liabilities related to such obligations in these financial statements.

7. Term Loans

Term loans consist of the following (in thousands):

December 31,

Unamortized debt discount (326 ) (939 )

Less: term loan, current — (7,500 )

Perceptive Term Loans

On June 30, 2017, the Company entered into a senior, secured, delayed-draw term loan facility (the Perceptive Term Loan Agreement) with Perceptive Credit Holdings, LP, as the administrative agent and the collateral agent, for various related Perceptive group companies to borrow up to $40.0 million (the Perceptive Term Loans). The Perceptive Term Loans bore interest at a rate of 8.55%, plus the greater of the three-month London Inter-bank Offered Rate (LIBOR) and 2.00%.

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In July 2020, the Company used the SVB Term Loan (see below) to repay in full all amounts due under the Perceptive Term Loan and cash on hand to pay $1.2 million in early prepayment, accrued interest and exit fees. The repayment of the Perceptive Term Loan was accounted for as a debt extinguishment, which resulted in a loss on extinguishment of $1.6 million recorded in the statements of operations for the year ended December 31, 2020.

SVB Loan and Security Agreement

On July 2, 2020, the Company entered into a senior secured term loan facility with Silicon Valley Bank (SVB) (the SVB Loan and Security Agreement), which provides for a $30.0 million term loan (the SVB Term Loan).

The SVB Term Loan matures on November 1, 2025. Payments under the SVB Term Loan are for interest only through May 2023, and then 30 monthly principal and interest payments from June 2023 until maturity. The SVB Term Loan bears interest at the greater of (A) 0.5% above the Prime Rate as reported in the Wall Street Journal and (B) 3.75% (3.75% as of December 31, 2020). The Company is obligated to maintain a restricted cash balance greater or equal to the outstanding principal balance of $30.0 million of the SVB Term Loan.

There is also a final payment fee equal to 6.75% of the original principal amount of the SVB Term Loan, or approximately $2.0 million, due at maturity (or any earlier date of optional pre-payment or acceleration of principal due to an event of default). Such fee is being accreted to interest expense using the effective interest method with the offset recorded in noncurrent accrued interest. The Company may, at its option, prepay the SVB Term Loan in full, subject to an additional prepayment fee ranging between 1% and 3% of the outstanding principal amount of the SVB Term Loan.

Debt issuance costs paid directly to SVB and other debt issuance costs amounting to $0.4 million were accounted for as discounts on the SVB Term Loan. These debt discounts, along with the final payment fee, are being amortized over the term of the SVB Term Loan using the effective interest rate method. As of December 31, 2020, the unamortized debt discount was $0.3 million, which is recorded as a direct deduction from the SVB Term Loan on the balance sheets.

Aggregate annual payments due on the SVB Term Loan as of December 31, 2020 were as follows (in thousands):

Years Ending December 31:

Total future payments 36,255

Less: amount representing interest (4,230 )

Less: final payment (2,025 )

Less: unamortized debt discount (326 )

Total term loan, net of debt discount 29,674

8. Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

Redeemable Convertible Preferred Stock

Immediately prior to the closing of the Company’s IPO, all of the outstanding shares of redeemable convertible preferred stock converted into 25,958,000 shares of common stock, excluding the 274,000 shares of common stock that were issued on the exercise of outstanding redeemable convertible preferred stock warrants.

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Preferred Stock

Upon the closing of the IPO, the Company’s amended and restated certificate of incorporation authorized 5,000,000 shares of undesignated preferred stock, $0.001 par value per share, the rights, preferences and privileges of which may be designated from time to time by the Company’s board of directors. As of December 31, 2020, no shares of the preferred stock were issued and outstanding.

Redeemable Convertible Preferred Stock Warrants and Common Stock Warrants

On the closing of the IPO, the aggregate outstanding Series A redeemable convertible preferred stock warrants of 500,000 shares converted into 63,000 common stock warrants with an exercise price of $7.96 per share, which resulted in the reclassification of the convertible preferred stock warrant liability of $1.2 million to additional paid-in capital. The common stock warrants expire in September 2025.

On the closing of the IPO, the aggregate outstanding Series B redeemable convertible preferred stock warrants of 2,176,000 shares were net exercised with an exercise price of $2.2674 per share, which resulted in the issuance of 65,000 shares of the Company’s common stock based on the IPO price of $27.00 per share. In addition, the aggregate outstanding Series C redeemable convertible preferred stock warrants of 1,655,000 shares were cash exercised at an exercise price of $2.5915 per share, which resulted in the issuance of 209,000 shares of the Company’s common stock with total aggregate cash proceeds of $4.3 million.

In 2009, the Company issued a warrant to purchase 8,860 shares of common stock with an exercise price of $8.61 per share and a fair value of $30,000 in connection with a product development agreement. The warrant was fully vested and exercised during the first quarter of 2019.

Common Stock

The Company has reserved shares of common stock, on an as-if converted basis, for issuance as of December 31, 2020 as follows (in thousands):

Warrants to purchase common stock 63

Stock options outstanding 4,763

Restricted stock units outstanding 44

Performance stock units outstanding 25

Shares available for future purchase under ESPP 687

Shares available for future grant under 2020 Plan 3,537

9. Equity Incentive Plan

In 2019, the Company terminated the 2010 Stock Incentive Plan (the 2010 Plan) and adopted the 2019 Equity Incentive Plan (the 2019 Plan, and together with 2010 Plan, the Prior Plans) for the purpose of providing incentive and non-statutory stock options to employees, directors and certain non-employees.

In September 2020, the Company adopted the 2020 Equity Incentive Plan (the 2020 Plan, and together with the Prior Plans, the Plans), which became effective in connection with the IPO. As a result, the Company may not grant any additional awards under the Prior Plans. The Prior Plans will continue to govern outstanding equity awards previously granted thereunder. The Company has initially reserved 3,665,000 shares of common stock for the issuance of awards under the 2020 Plan. In addition, the number of shares of common stock available under the 2020 Plan will automatically increase on the first day of each fiscal year, commencing January 2021, and continuing until (and including) the fiscal year ending December 31, 2030, with such annual increase equal to an amount equal to the lesser of (i) 4% of the number of shares of common stock issued and outstanding on December 31 of the immediately preceding calendar year, and (ii) an amount determined by the Company’s board of directors.

Options under the 2020 Plan have a contractual term of 10 years. The exercise price of an option shall not be less than 100% of the fair market value of the shares on the date of grant.

122

Stock Options

A summary of the Company’s stock option activity under the Plans is set forth below (in thousands, except exercise price and remaining contractual life data):

Forfeited and expired (117 ) $ 7.28

The weighted average grant date fair value of options granted to employees was $7.97, $2.77 and $1.90 per share during the years ended December 31, 2020, 2019 and 2018, respectively. The total intrinsic value of options exercised during the years ended December 31, 2020, 2019 and 2018 was $8.2 million, $0.2 million and $0.1 million, respectively. The intrinsic value is the difference between the estimated fair value of the Company’s common stock at the time of exercise and the exercise price of the stock option.

The total fair value of options that vested during the years ended December 31, 2020, 2019 and 2018 was $3.3 million, $0.7 million and $0.7 million, respectively. As of December 31, 2020, the total unrecognized stock-based compensation expense related to the stock options, excluding stock options with market and performance conditions, was $6.2 million, which will be recognized over a weighted-average period of approximately 1.32 years.

Stock Options with Performance and Market Conditions

During the years ended December 31, 2020, 2019 and 2018, the Company granted 504,000, 632,000 and 321,000 shares of stock options with performance and market-based conditions to employees and executive officers. The options vest over the requisite service period if the Company achieves both (i) a performance condition tied to a liquidity event, which includes the effectiveness of an IPO, and (ii) certain market conditions, provided the optionee is providing services on the date of the event. In February 2020, the Company modified the market conditions, which resulted in a new grant date fair value for 1,457,000 stock options with performance and market-based conditions as of the modification date. As of December 31, 2020, 1,933,000 shares of these stock options were outstanding.

For the year ended December 31, 2020, the Company recorded cumulative stock-based compensation expense of $18.5 million related to all outstanding stock options with performance and market-based vesting conditions as the performance vesting condition was satisfied upon the closing of the IPO. As of December 31, 2020, 152,000 shares of these options were fully vested. Unamortized stock-based compensation expense amounted to $4.8 million as of December 31, 2020, which the Company expects to recognize over an estimated weighted-average period of 0.29 years.

Stock Option Valuation Assumptions

The fair value of each stock option grant is estimated on the date of grant using the following assumptions for the periods indicated:

Years Ended December 31,

Dividend yield 0% 0% 0%

123

Restricted Stock

The Company issues RSUs and PSUs, both of which are considered restricted stock. The Company grants restricted stock pursuant to the 2020 Plan and satisfies such grants through the issuance of new shares. RSUs are share awards that, upon vesting, will deliver to the holder shares of our common stock. The PSUs vest over the requisite service period if the Company achieves specified revenue targets. The PSUs vest in a range between 0% and 200% of the units approved based on the performance relative to specified revenue targets.

Restricted stock activity was as follows (in thousands, except per share amounts):

(RSU) (PSU) RSU PSU

Outstanding as of December 31, 2019 — — — —

Vested (5 ) — $ (43.26 ) —

The total grant date fair value of RSUs vested for the year ended December 31, 2020 was $0.2 million. There were no RSUs granted prior to 2020. As of December 31, 2020, the total unrecognized stock-based compensation expense related to the RSUs was $2.2 million, which will be recognized over a weighted-average period of approximately 3.12 years.

As of December 31, 2020, the achievement of the performance goal for PSUs was not considered probable. As a result, no associated expense was recognized during the year ended December 31, 2020. There were no PSUs granted prior to 2020. The total unrecognized stock-based compensation expense related to the PSUs was $1.3 million as of December 31, 2020.

Employees Stock Purchase Plan (ESPP)

In September 2020, the Company adopted the Employee Stock Purchase Plan (ESPP). The Company has initially reserved 687,000 shares of common stock for purchase under the ESPP. In addition, the number of shares of common stock available for issuance under the ESPP will automatically increase on the first day of each fiscal year, commencing January 2021 and continuing until (and including) the fiscal year ending December 31, 2030, with such annual increase equal to the lesser of (i) 687,000 shares, (ii) 1% of the number of common stock issued and outstanding on December 31 of the immediately preceding fiscal year, and (iii) an amount determined by the Company’s board of directors.

Subject to any limitations contained therein, the ESPP allows eligible participants to contribute, through payroll deductions, up to 15% of their eligible compensation to purchase the Company’s common stock at a purchase price equal to 85% of the fair market value of the common stock on the first day of the offering period or purchase date, whichever is lower.The ESPP generally provides for consecutive 6-month offering periods. The initial offering period began on September 15, 2020 and ran through February 26, 2021.

The fair value of the stock purchase rights under the ESPP is estimated using the Black-Scholes option pricing model. For the year ended December 31, 2020, the grant date fair value was $8.00 and estimated using the following assumptions:

OM US Equity

OM · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Item 8. Financial Statements and Supplementary Data.

OM US Equity☆

OM · 10-K · period ended 2020-12-31

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Item 7A. Quantitative and Qualitative Disclosures About Market Risk.

Item 8. Financial Statements and Supplementary Data.

OM US Equity