Penumbra Inc: Form 10-Q for the period ended Sep 30, 2023

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited condensed consolidated financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations for the year ended December 31, 2022, included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (“SEC”) on February 23, 2023.

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). In some cases, you can identify these statements by forward-looking words such as “may,” “will,” “expect,” “believe,” “anticipate,” “intend,” “could,” “should,” “estimate,” or “continue,” and similar expressions or variations, but these words are not the exclusive means for identifying such statements. Such forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results and the timing of certain events to differ materially from future results and timing expressed or implied by such forward-looking statements. Factors that could cause or contribute to such differences include, but are not limited to, those identified below, and those discussed in the section titled “Risk Factors” in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2022. The forward-looking statements in this Quarterly Report on Form 10-Q represent our views as of the date of this Quarterly Report on Form 10-Q. Except as may be required by law, we assume no obligation to update these forward-looking statements or the reasons that results could differ from these forward-looking statements. You should, therefore, not rely on these forward-looking statements as representing our views as of any date subsequent to the date of this Quarterly Report on Form 10-Q.

Overview

Penumbra is a global healthcare company focused on innovative therapies. We design, develop, manufacture and market novel products and have a broad portfolio that addresses challenging medical conditions in markets with significant unmet need. Our team focuses on developing, manufacturing and marketing novel products for use by specialist physicians and healthcare providers to drive improved clinical outcomes and health. We believe that the cost-effectiveness of our products is attractive to our customers.

Since our founding in 2004, we have invested heavily in our product development capabilities in our major markets: neuro, vascular, and immersive healthcare. We have successfully developed, obtained regulatory clearance or approval for, and introduced products into the neurovascular market since 2007, vascular market since 2013, neurosurgical market since 2014, and immersive healthcare market since 2020, respectively. We continue to expand our portfolio of product offerings, while developing and iterating on our currently available products.

We expect to continue to develop and build our portfolio of products, including our thrombectomy, embolization and access and immersive technologies. Generally, when we introduce a next generation product or a new product designed to replace a current product, sales of the earlier generation product or the product replaced decline. Our research and development activities are centered around the development of new products and clinical activities designed to support our regulatory submissions and demonstrate the effectiveness of our products.

To address the challenging and significant clinical needs of our key markets, we have developed products that fall into the following broad product families:

Our neuro products fall into four broad product families:

• Neuro thrombectomy - Penumbra System, including Penumbra RED, JET, ACE catheters and the 3D Revascularization Device, Penumbra ENGINE and other components and accessories
• Neuro embolization - Penumbra SMART COIL, Penumbra Coil 400, POD400 and PAC400
• Neuro access - delivery catheters, consisting of Neuron, Neuron MAX Select, BENCHMARK, BMX96, BMX81, DDC, PX SLIM and SENDit
• Neurosurgical - Artemis Neuro Evacuation Device

Our vascular products fall into two broad product families:

• Vascular thrombectomy - INDIGO System designed for continuous or modulated aspiration, computer assisted vacuum thrombectomy, including aspiration catheters, microprocessor-controlled software algorithms that orchestrate the interaction of our pump and catheters, separators, aspiration pump and accessories
• Peripheral embolization - RUBY Coil System, Ruby LP, LANTERN Delivery Microcatheter and the POD System (POD and POD Packing Coil)

Our immersive healthcare products fall into one broad product family:

• REAL Immersive System - portfolio of products that leverages immersive computer-based technologies to deliver engaging, immersive therapeutics to promote better health, motor function and cognition

We support healthcare providers, hospitals and clinics in more than 100 countries. In the nine months ended September 30, 2023 and 2022, 28.5% and 30.6% of our revenue, respectively, was generated from customers located outside of the United States. Our sales outside of the United States are denominated principally in the euro and Japanese yen, with some sales being denominated in other currencies. As a result, we have foreign exchange exposure but do not currently engage in hedging.

We generated revenue of $773.8 million and $625.9 million for the nine months ended September 30, 2023 and 2022, respectively, an increase of $147.9 million. We generated income from operations of $38.5 million, which includes the $18.2 million acquired in-process research and development (“IPR&D”) charge recorded in connection with an asset acquisition, and $1.2 million for the nine months ended September 30, 2023 and 2022, respectively.

Factors Affecting Our Performance

There are a number of factors that have impacted, and we believe will continue to impact, our results of operations and growth. These factors include:

• The COVID-19 pandemic and measures taken in response thereto, which have negatively affected, and may continue to negatively affect, our revenues and results of operations. For example, as a result of the pandemic and the response thereto, global supply chains have been impacted, and we may experience significant and unpredictable fluctuations in the availability and cost of components and raw materials used in our products.
• The rate at which we grow our salesforce and the speed at which newly hired salespeople become fully effective can impact our revenue growth or our costs incurred in anticipation of such growth.
• Our industry is intensely competitive and, in particular, we compete with a number of large, well-capitalized companies. We must continue to successfully compete in light of our competitors’ existing and future products and their resources to successfully market to the specialist physicians and other healthcare providers who use our products.
• We must continue to successfully introduce new products that gain acceptance with specialist physicians and other healthcare providers and successfully transition from existing products to new products, ensuring adequate supply. In addition, as we introduce new products and expand our production capacity, we anticipate additional personnel will be hired and trained to build our inventory of components and finished goods in advance of sales, which may cause quarterly fluctuations in our operating results and financial condition.
• Publications of clinical results by us, our competitors and other third parties can have a significant influence on whether, and the degree to which, our products are used by specialist physicians and the procedures and treatments those physicians choose to administer for a given condition.
• The specialist physicians who use our interventional products may not perform procedures during certain times of the year, such as those periods when they are at major medical conferences or are away from their practices for other reasons, the timing of which occurs irregularly during the year and from year to year.
• Most of our sales outside of the United States are denominated in the local currency of the country in which we sell our products. As a result, our revenue from international sales can be significantly impacted by fluctuations in foreign currency exchange rates.
• The availability and levels of reimbursement within the relevant healthcare payment system for healthcare providers for procedures in which our products are used.

In addition, we have experienced and expect to continue to experience meaningful variability in our quarterly revenue, gross profit and gross margin percentage as a result of a number of factors, including, but not limited to: the number of available selling days, which can be impacted by holidays; the mix of products sold; the geographic mix of where products are sold; the demand for our products and the products of our competitors; the timing of or failure to obtain regulatory approvals or clearances for products; increased competition; the timing of customer orders; inventory write-offs due to obsolescence; costs, benefits and timing of new product introductions; costs, benefits and timing of the acquisition and integration of businesses and product lines we may acquire; the availability and cost of components and raw materials; and fluctuations in foreign currency exchange rates. We may experience quarters in which we have significant revenue growth sequentially followed by quarters of moderate or no revenue growth. Additionally, we may experience quarters in which operating expenses, in particular research and development expenses, fluctuate depending on the stage and timing of product development.

COVID-19 Pandemic

In March 2020, the World Health Organization declared the outbreak of COVID-19 as a pandemic, which spread throughout the U.S. and the world. In response, governments issued orders restricting certain activities, and while our business falls within the category of healthcare operations, which are essential businesses that have generally been permitted to continue operating during the COVID-19 pandemic, we have experienced, and may continue to experience, disruptions to our operations as a result of the pandemic. For example, at times during the pandemic, hospital resources have been diverted to fight the pandemic, and many government agencies, in conjunction with healthcare systems, have recommended the deferral of elective and semi-elective medical procedures. In addition, the pandemic and the response thereto have impacted global supply chains and labor markets, resulting in cost inflation and raw material supply constraints, as well as an increase in employee turnover rates in certain jurisdictions, which has impacted, and may continue to impact, our business. In order to navigate the pandemic, we made certain changes to how we manufacture, inspect and ship our products to prioritize the health and safety of our employees and to operate under the protocols mandated by our local and state governments.

While the acute phase of the pandemic has subsided due to the development and widespread availability of vaccines for COVID-19,we are unable to reliably predict the full impact that COVID-19 will have on our business due to numerous uncertainties, including the severity and duration of the pandemic, the global resurgences of cases, particularly as new variants of the virus spread, additional actions that may be taken by governmental authorities in response to the pandemic, the impact of the pandemic on the business of our customers, distributors and suppliers, other businesses and worldwide economies in general, our ability to have access to our customers to provide training and case support, and other factors identified in Part I, Item 1A “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022. We will continue to evaluate the nature and extent of the impact of COVID-19 on our business, consolidated results of operations, and financial condition.

Components of Results of Operations

Revenue. We sell our interventional products directly to hospitals and other healthcare providers and through distributors for use in procedures performed by specialist physicians to treat patients in two key markets: neuro and vascular disease. We sell our products through purchase orders, and we do not have long term purchase commitments from our customers. Revenue from product sales is recognized either on the date of shipment or the date of receipt by the customer, but is deferred for certain transactions when control has not yet transferred. With respect to products that we consign to hospitals, which primarily consist of coils, we recognize revenue at the time hospitals utilize products in a procedure. Revenue also includes shipping and handling costs that we charge to customers.

Cost of Revenue. Cost of revenue consists primarily of the cost of raw materials and components, personnel costs, including stock-based compensation, inbound freight charges, receiving costs, inspection and testing costs, warehousing costs, royalty expense, shipping and handling costs, and other labor and overhead costs incurred in the manufacturing of products. In addition, we record write-downs or write-offs of inventory in the event that a portion of our inventory becomes excess or obsolete.

We manufacture substantially all of our products in our manufacturing facilities in Alameda and Roseville, California.

Operating Expenses

Research and Development (“R&D”). R&D expenses primarily consist of product development, clinical and regulatory expenses, materials, depreciation and other costs associated with the development of our products. R&D expenses also include salaries, benefits and other related costs, including stock-based compensation, for personnel and consultants. We generally expense R&D costs as they are incurred, with the exception of certain costs incurred for the development of computer software for internal use related to our REAL Immersive System offerings. We capitalize certain costs when it is determined that it is probable that the project will be completed and the software will be used to perform the function intended, and the preliminary project stage is completed. Capitalized internal use software development costs are included in property and equipment, net within the condensed consolidated balance sheets.

Sales, General and Administrative (“SG&A”). SG&A expenses primarily consist of salaries, benefits and other related costs, including stock-based compensation, for personnel and consultants engaged in sales, marketing, finance, legal, compliance, administrative, facilities, information technology and human resource activities. Our SG&A expenses also include marketing trials, medical education, training, commissions, generally based on sales, to direct sales representatives, amortization of acquired intangible assets and acquisition-related costs.

Provision For (Benefit from) Income Taxes

We are taxed at the rates applicable within each jurisdiction in which we operate. The composite income tax rate, tax provisions, deferred tax assets (“DTAs”) and deferred tax liabilities will vary according to the jurisdiction in which profits arise. Tax laws are complex and subject to different interpretations by management and the respective governmental taxing authorities, and require us to exercise judgment in determining our income tax provision, our deferred tax assets and deferred tax liabilities and the potential valuation allowance recorded against our net DTAs. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the years in which those tax assets are expected to be realized. A valuation allowance is established when it is more likely than not that the future realization of all or some of the DTAs will not be achieved.

Results of Operations

The following table sets forth the components of our condensed consolidated statements of operations in dollars and as a percentage of revenue for the periods presented:

(in thousands, except for percentages)

(in thousands, except for percentages)

Three Months Ended September 30, 2023 Compared to the Three Months Ended September 30, 2022

Revenue

(in thousands, except for percentages)

Revenue increased $57.3 million, or 26.8%, to $270.9 million in the three months ended September 30, 2023, from $213.7 million in the three months ended September 30, 2022. Overall revenue growth was primarily due to an increase in sales of new and existing products within our vascular and neuro businesses.

Revenue from our vascular products increased $48.0 million, or 38.9%, to $171.4 million in the three months ended September 30, 2023, from $123.4 million in the three months ended September 30, 2022. This increase was driven by a 50.2% increase in sales of our vascular thrombectomy products in the United States and primarily attributable to sales of new products and further market penetration of our existing products. Prices for our vascular products remained substantially unchanged during the period.

Revenue from our neuro products increased $9.2 million, or 10.2%, to $99.5 million in the three months ended September 30, 2023, from $90.3 million in the three months ended September 30, 2022. This increase was primarily attributable to sales of new products in United States and Europe and further market penetration of our existing products. The increase in product sales was driven by an increase in sales of our neuro access products and neuro thrombectomy products, which globally increased by 12.9% and 10.3%, respectively, in the three months ended September 30, 2023, partially offset by a decrease in sales of our neuro embolization products, which decreased by 18.8% in the three months ended September 30, 2023. Prices for our neuro products remained substantially unchanged during the period.

Revenue by Geographic Area

The following table presents revenue by geographic area, based on our customers’ shipping destinations, for the three months ended September 30, 2023 and 2022:

(in thousands, except for percentages)

Revenue from product sales in international markets increased $11.3 million, or 17.4%, to $76.1 million in the three months ended September 30, 2023, from $64.9 million in the three months ended September 30, 2022. Revenue from international sales represented 28.1% and 30.4% of our total revenue for the three months ended September 30, 2023 and 2022, respectively.

Gross Margin

(in thousands, except for percentages)

Gross margin increased by 2.3 percentage points to 65.6% in the three months ended September 30, 2023, from 63.3% in the three months ended September 30, 2022. Gross margin is impacted by product mix, regional mix, and production initiatives to support demand and create future efficiencies. As such, with favorable product mix, improvement in productivity, and by leveraging our fixed costs on higher volume of new product sales during the year, our gross margin may be positively impacted in the future.

Research and Development (“R&D”)

(in thousands, except for percentages)

R&D expenses decreased by $0.4 million, or 1.7%, to $21.0 million in the three months ended September 30, 2023, from $21.3 million in the three months ended September 30, 2022. The decrease was primarily due to a $1.6 million decrease in product development and testing costs, partially offset by a $1.2 million increase in personnel-related expenses.

We have continued to make investments, and plan to continue to make investments, in the development of our products. As part of our ongoing investment in the development of our products, we may incur additional expenses related to research and development milestones. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of clinical trials and product development, which may include additional personnel-related expenses in conjunction with the launch of new products.

Sales, General and Administrative (“SG&A”)

(in thousands, except for percentages)

SG&A expenses increased by $17.3 million, or 16.0%, to $125.9 million in the three months ended September 30, 2023, from $108.6 million in the three months ended September 30, 2022. The increase was primarily due to a $11.0 million increase in personnel-related expenses driven by an increase in headcount and related expenses to support our growth and a $3.0 million increase in costs related to marketing events.

As we continue to invest in our growth, we have expanded and may continue to expand our sales, marketing, and general and administrative teams through the hiring of additional employees in critical roles that support our strategic initiatives. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of investments to support the business.

Acquired In-Process Research and Development

(in thousands, except for percentages)

During the three months ended September 30, 2023, we recorded an $18.2 million acquired IPR&D charge in connection with an asset acquisition.

Provision for income taxes

(in thousands, except for percentages)

Our provision for income taxes was $4.1 million for the three months ended September 30, 2023, which was primarily due to tax expenses attributable to our worldwide profits and a discrete tax charge resulting from the non-deductible IPR&D charge associated with an asset acquisition (see Note “5. Asset Acquisition” to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information), offset by excess tax benefits from stock-based compensation attributable to our U.S. jurisdiction. Our provision for income taxes was $5.3 million for the three months ended September 30, 2022, which was primarily due to tax expenses attributable to our worldwide profits, combined with tax deficiencies (shortfalls) expenses from stock based compensation attributable to our U.S. jurisdiction as a result of stock price fluctuation.

Our effective tax rate changed to 30.7% for the three months ended September 30, 2023 from 174.8% for the three months ended September 30, 2022, primarily due to small tax expenses over relatively large worldwide profits for the three months in 2023 comparing to large tax expenses over relatively small worldwide profits for the three months in 2022.

Prospectively, our effective tax rate will likely be driven by (1) permanent differences in taxable income for tax and financial reporting purposes, (2) tax expense or benefit attributable to our worldwide financial result, and (3) discrete tax adjustments such as excess tax benefits or deficiencies related to stock-based compensation. Our income tax provision is subject to volatility as the amount of excess tax benefits or deficiencies can fluctuate from period to period based on the price of our stock, the volume of share-based grants settled or vested, and the fair value assigned to equity awards under U.S. GAAP.

As of September 30, 2023 and 2022, we maintain a valuation allowance against our Federal Research and Development Tax Credit DTAs as we could not conclude at the required more-likely-than-not level of certainty, that the benefit of these tax attributes would be realized prior to expiration. We intend to continue maintaining this full valuation allowance until there is sufficient evidence to reverse it. However, considering current earnings and anticipated future earnings, as well as the impact of IRC Section 174 requiring qualified research expenditures to be capitalized and amortized over 5 or 15 years, we anticipate net operating loss (“NOL”) utilization may be accelerated. As a consequence, we believe there is a reasonable possibility that sufficient positive evidence may become available to conclude this valuation allowance may no longer be needed within the next 12 months. Release of the valuation allowance will result in the recognition of Federal Research and Development Tax Credit DTAs and a decrease to income tax expenses for the period in which the release is recorded. The exact timing and amount of the valuation allowance release are highly dependent on the level of taxable income in future years. We will continue to closely monitor the need for this valuation allowance in each subsequent reporting period.

Nine Months Ended September 30, 2023 Compared to the Nine Months Ended September 30, 2022

Revenue

(in thousands, except for percentages)

Revenue increased $147.9 million, or 23.6%, to $773.8 million in the nine months ended September 30, 2023, from $625.9 million in the nine months ended September 30, 2022. Overall revenue growth was primarily due to an increase in sales of new and existing products within our vascular and neuro businesses.

Revenue from our vascular products increased $97.2 million, or 26.3%, to $466.9 million in the nine months ended September 30, 2023, from $369.7 million in the nine months ended September 30, 2022. This increase in revenue from our vascular products was primarily attributable to increased revenue in the United States and was driven by sales of our vascular thrombectomy products and peripheral embolization products, which globally increased by 34.6% and 12.2%, respectively, in the nine months ended September 30, 2023. These increases were primarily due to higher sales volume in the United States as a result of sales of new products and further market penetration of our existing products. Prices for our vascular products remained substantially unchanged during the period.

Revenue from our neuro products increased $50.7 million, or 19.8%, to $306.9 million in the nine months ended September 30, 2023, from $256.2 million in the nine months ended September 30, 2022. This increase in revenue from our neuro products was primarily attributable to increased revenue in the United States and Europe, sales of new products, and further market penetration of our existing products. This increase was driven by an increase in sales of our neuro access products and neuro thrombectomy products, which globally increased by 24.9% and 20.1%, respectively, in the nine months ended September 30, 2023, partially offset by a decrease in sales of our neuro embolization products of 16.2% in the nine months ended September 30, 2023. Prices for our neuro products remained substantially unchanged during the period.

Revenue by Geographic Area

The following table presents revenue by geographic area, based on our customer’s shipping destination, for the nine months ended September 30, 2023 and 2022:

(in thousands, except for percentages)

Revenue from sales in international markets increased $29.0 million, or 15.2%, to $220.4 million in the nine months ended September 30, 2023, from $191.3 million in the nine months ended September 30, 2022. Revenue from international sales represented 28.5% and 30.6% of our total revenue for the nine months ended September 30, 2023 and 2022, respectively.

Gross Margin

(in thousands, except for percentages)

Gross margin increased by 0.7 percentage point to 64.1% in the nine months ended September 30, 2023, from 63.4% in the nine months ended September 30, 2022. Gross margin is impacted by product mix, regional mix, start-up costs associated with new product launches, and production initiatives to support demand and create future efficiencies. As such, with favorable product mix, improvement in productivity, and by leveraging our fixed costs on higher volume of new product sales during the year, our gross margin may be positively impacted in the future.

Research and Development (“R&D”)

(in thousands, except for percentages)

R&D expenses increased by $1.0 million, or 1.7%, to $62.5 million in the nine months ended September 30, 2023, from $61.4 million in the nine months ended September 30, 2022. The increase was primarily due to a $3.8 million increase in personnel-related expenses, partially offset by a $3.1 million decrease in product development and testing costs.

We have continued to make investments, and plan to continue to make investments, in the development of our products. As part of our ongoing investment in the development of our products, we may incur additional expenses related to research and development milestones. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of clinical trials and product development, which may include additional personnel-related expenses in conjunction with the launch of new products.

Sales, General and Administrative (SG&A)

(in thousands, except for percentages)

SG&A expenses increased by $42.3 million, or 12.7%, to $376.4 million in the nine months ended September 30, 2023, from $334.1 million in the nine months ended September 30, 2022. The increase was primarily due to a $30.7 million increase in personnel-related expense driven by an increase in headcount and related expenses to support our growth and a $4.9 million increase in costs related to marketing events.

As we continue to invest in our growth, we have expanded and may continue to expand our sales, marketing, and general and administrative teams through the hiring of additional employees in critical roles that support our strategic initiatives. In addition, we have experienced in the past, and may continue to experience in the future, variability in expenses incurred due to the timing and costs of investments to support the business.

Acquired In-Process Research and Development

(in thousands, except for percentages)

During the nine months ended September 30, 2023, we recorded an $18.2 million acquired IPR&D charge in connection with an asset acquisition.

Provision for income taxes

(in thousands, except for percentages)

Our provision for income taxes was $4.8 million for the nine months ended September 30, 2023, which was primarily due to tax expenses attributable to our worldwide profits and a discrete tax charge resulting from the non-deductible IPR&D charge associated with an asset acquisition (see Note “5. Asset Acquisition” to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information), offset by excess tax benefits from stock-based compensation attributable to our U.S. jurisdiction. Our benefit from income taxes was $2.6 million for the nine months ended September 30, 2022, which was primarily due to tax expenses attributable to our foreign profits, combined with tax deficiencies (shortfalls) expenses from stock-based compensation attributable to our U.S. jurisdiction as a result of stock price fluctuation.

The effective tax rate changed to 11.5% for the nine months ended September 30, 2023 from (81.7)% for the nine months ended September 30, 2022, primarily due to small tax expenses over relatively large worldwide profits for the nine months in 2023 comparing to large tax expenses over relatively small worldwide losses for the nine months in 2022.

Prospectively, our effective tax rate will likely be driven by (1) permanent differences in taxable income for tax and financial reporting purposes, (2) tax expense or benefit attributable to our worldwide financial results, and (3) discrete tax adjustments such as excess tax benefits or deficiencies related to stock-based compensation. Our income tax provision can be volatile as the amount of excess tax benefits or deficiencies can fluctuate from period to period due to the price of our stock, the volume of share-based grants exercised or vested, and the fair value assigned to equity awards under U.S. GAAP. In addition, changes in tax law or our interpretation thereof, and changes to our valuation allowance could result in fluctuations in our effective tax rate.

As of September 30, 2023 and 2022, we maintain a valuation allowance against our Federal Research and Development Tax Credit DTAs as we could not conclude at the required more-likely-than-not level of certainty, that the benefit of these tax attributes would be realized prior to expiration. We intend to continue maintaining this full valuation allowance until there is sufficient evidence to reverse it. However, considering current earnings and anticipated future earnings, as well as the impact of IRC Section 174 requiring qualified research expenditures to be capitalized and amortized over 5 or 15 years, we anticipate net operating loss (“NOL”) utilization may be accelerated. As a consequence, we believe there is a reasonable possibility that sufficient positive evidence may become available to conclude this valuation allowance may no longer be needed within the next 12 months. Release of the valuation allowance will result in the recognition of Federal Research and Development Tax Credit DTAs and a decrease to income tax expenses for the period in which the release is recorded. The exact timing and amount of the valuation allowance release are highly dependent on the level of taxable income in future years. We will continue to closely monitor the need for this valuation allowance in each subsequent reporting period.

Liquidity and Capital Resources

As of September 30, 2023, we had $723.4 million in working capital, which included $100.8 million in cash and cash equivalents and $148.1 million in marketable investments. As of September 30, 2023, we held approximately 16.9% of our cash and cash equivalents in foreign entities.

In addition to our existing cash and cash equivalents and marketable investment balances, our principal source of liquidity is our accounts receivable. In order to further strengthen our liquidity position and financial flexibility, on April 24, 2020 we entered into a Credit Agreement (the “Credit Agreement”) with JPMorgan Chase Bank, N.A., as administrative agent and lender, and Bank of America, N.A. and Citibank, N.A. as lenders. The Credit Agreement is secured and provides for up to $100 million in available revolving borrowing capacity with an option, subject to certain conditions, for us to increase the aggregate borrowing capacity to up to $150 million. The Credit Agreement originally matured on April 23, 2021 and was subsequently amended during the three months ended March 31, 2021, 2022 and 2023 to extend the maturity date and make other changes to the terms of the Credit Agreement. The Credit Agreement currently matures on February 16, 2024. See Note “8. Indebtedness” to our condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q for more information.

We believe these sources of liquidity will be sufficient to meet our liquidity requirements for at least the next 12 months. Our principal liquidity requirements are to fund our operations, expand manufacturing operations which includes, but is not limited to, maintaining sufficient levels of inventory to meet the anticipated demand of our customers, fund research and development activities and fund our capital expenditures. We may also lease or purchase additional facilities to facilitate our growth. We expect to continue to make investments as we launch new products, expand our manufacturing operations and information technology infrastructures and further expand into international markets. We may, however, require or elect to secure additional financing as we continue to execute our business strategy. If we require or elect to raise additional funds, we may do so through equity or debt financing, which may not be available on favorable terms, could result in dilution to our stockholders, could result in changes to our capital structure, and could require us to agree to covenants that limit our operating flexibility.

The following table summarizes our cash and cash equivalents, marketable investments and selected working capital data as of September 30, 2023 and December 31, 2022:

(in thousands)

(1) Working capital consists of total current assets less total current liabilities.

The following table sets forth, for the periods indicated, our beginning balance of cash and cash equivalents, net cash flows provided by (used in) operating, investing and financing activities and our ending balance of cash and cash equivalents:

(in thousands)

Net Cash Provided By (Used In) Operating Activities

Net cash provided by (used in) operating activities consists primarily of consolidated net income adjusted for certain non-cash items (including depreciation and amortization, stock-based compensation expense, acquired in-process research and development, inventory write-downs, and changes in deferred tax balances), and the effect of changes in working capital and other activities.

Net cash provided by operating activities was $61.1 million during the nine months ended September 30, 2023 and consisted of consolidated net income of $36.7 million and non-cash items of $86.0 million, offset by net changes in operating assets and liabilities of $61.7 million. The change in operating assets and liabilities primarily relates to an increase in inventories of $46.5 million to support our growth, an increase in accounts receivable of $6.6 million due to timing of invoicing and collections, and an increase in prepaid expenses and other current and non-current assets of $10.3 million. This was partially offset by an increase in accounts payable of $2.1 million due to timing of payments.

Net cash used in operating activities was $57.0 million during the nine months ended September 30, 2022 and consisted of consolidated net loss of $5.9 million and non-cash items of $51.0 million, offset by net changes in operating assets and liabilities of $102.1 million. The change in operating assets and liabilities includes an increase in inventories of $62.3 million to support our growth, an increase in accounts receivable of $57.4 million due to timing of receipt of payment, and an increase in prepaid expenses and other current and non-current assets of $2.0 million. This was partially offset by an increase in accounts payable of $13.1 million, an increase in accrued expenses and other non-current liabilities of $6.2 million, and proceeds of $0.3 million received related to lease incentives from operating leases.

Net Cash (Used In) Provided By Investing Activities

Net cash (used in) provided by investing activities relates primarily to purchases of marketable investments, net of proceeds from maturities and sales, capital expenditures and payments in connection with asset acquisitions.

Net cash used in investing activities was $40.4 million during the nine months ended September 30, 2023 and primarily consisted of $27.3 million in purchases of marketable investments, net of proceeds from maturities, capital expenditures of $11.6 million and $1.0 million in payments in connection with an asset acquisition.

Net cash provided by investing activities was $46.2 million during the nine months ended September 30, 2022 and primarily consisted of proceeds from maturities and sales of marketable investments of $61.9 million, partially offset by capital expenditures of $15.7 million.

Net Cash Provided By Financing Activities

Net cash provided by financing activities primarily relates to payments of employee taxes related to vested restricted stock units, payments towards the reduction of our finance lease obligations, and proceeds from exercises of stock options and issuance of common stock under our employee stock purchase plan.

Net cash provided by financing activities was $10.3 million during the nine months ended September 30, 2023 and primarily consisted of proceeds from the issuance of common stock under our employee stock purchase plan of $8.4 million and proceeds from exercises of stock options of $4.7 million, partially offset by $1.5 million in payments towards finance leases and $1.1 million of payments of employee taxes related to vested restricted stock units.

Net cash provided by financing activities was $5.9 million during the nine months ended September 30, 2022 and primarily consisted of proceeds from the issuance of common stock under our employee stock purchase plan of $8.0 million and proceeds from exercises of stock options of $6.3 million. This was partially offset by $7.0 million of payments of employee taxes related to vested restricted stock units and $1.3 million in payments towards finance leases.

Contractual Obligations and Commitments

There have been no other material changes to our contractual obligations and commitments as of September 30, 2023 from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2022.

Critical Accounting Policies and Estimates

We have prepared our financial statements in accordance with U.S. GAAP. Our preparation of these financial statements requires us to make estimates, assumptions, and judgments that affect the reported amounts of assets, liabilities, expenses, and related disclosures at the date of the financial statements, as well as revenue and expenses recorded during the reporting periods. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results could therefore differ materially from these estimates under different assumptions or conditions.

There have been no material changes to our critical accounting policies from those described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our Annual Report on Form 10-K for the year ended December 31, 2022.

Recently Issued Accounting Standards

No recently issued accounting standards are expected to impact the Company.

We are exposed to various market risks, which may result in potential losses arising from adverse changes in market rates, such as interest rates and foreign exchange rates. We do not enter into derivatives or other financial instruments for trading or speculative purposes and do not believe we are exposed to material market risk with respect to our cash and cash equivalents or our marketable investments.

Interest Rate Risk. We had cash and cash equivalents of $100.8 million as of September 30, 2023, which consisted of funds held in money market funds, general checking and savings accounts. In addition, we had marketable investments of $148.1 million, which consisted primarily of corporate bonds, certificate of deposit, U.S. agency and government sponsored securities, and U.S. states and municipalities. Our investment policy is focused on the preservation of capital and supporting our liquidity needs. Under the policy, we invest in highly rated securities, while limiting the amount of credit exposure to any one issuer other than the U.S. government. We do not invest in financial instruments for trading or speculative purposes, nor do we use leveraged financial instruments. We utilize external investment managers who adhere to the guidelines of our investment policy. The revolving loans under the Credit Agreement bear interest at: (1) the adjusted EURIBOR rate, plus an applicable rate, for euro currency revolving borrowing; or (2) an alternate base rate, daily simple SOFR, or adjusted term SOFR rate, as applicable, plus an applicable rate, for revolving borrowing in U.S. dollars. As of September 30, 2023, there were no borrowings outstanding under the Credit Agreement. A hypothetical 100 basis point change in interest rates would not have a material impact on the value of our cash and cash equivalents or marketable investments.

Foreign Exchange Risk Management. We operate in countries other than the United States, and, therefore, we are exposed to foreign currency risks. We bill most sales outside of the United States in local currencies, primarily euro and Japanese yen, with some sales being denominated in other currencies. We expect that the percentage of our sales denominated in foreign currencies may increase in the foreseeable future as we continue to expand into international markets. When sales or expenses are not denominated in U.S. dollars, a fluctuation in exchange rates could affect our net income. We do not believe our net income would be materially impacted by an immediate 10% adverse change in foreign exchange rates. We do not currently hedge our exposure to foreign currency exchange rate fluctuations; however, we may choose to hedge our exposure in the future.

While our gross margin for the nine months ended September 30, 2023 was primarily impacted by product mix, regional mix, start-up costs associated with new product launches, and production initiatives to support demand and create future efficiencies, changes in prices did not have a significant impact on our results of operations for any periods presented on our consolidated financial statements.

Evaluation of Disclosure Controls and Procedures

An evaluation as of September 30, 2023 was carried out under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of our “disclosure controls and procedures,” which are defined in Rule 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as controls and other procedures of a company that are designed to ensure that the information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to the company’s management, including its principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. Based upon that evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were effective at September 30, 2023.

Changes in Internal Control Over Financial Reporting

There was no change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the quarterly period ended September 30, 2023 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Limitations on the Effectiveness of Controls

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Because of inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues, if any, within a company have been detected. Accordingly, our disclosure controls and procedures are designed to provide reasonable, not absolute, assurance that the objectives of our disclosure control system are met and, as set forth above, our principal executive officer and principal financial officer have concluded, based on their evaluation as of the end of the period covered by this report, that our disclosure controls and procedures were effective to provide reasonable assurance that the objectives of our disclosure control system were met.

There have been no material changes to our risk factors reported in, or new risk factors identified since the filing of, our Annual Report on Form 10-K for the year ended December 31, 2022, which was filed with the SEC on February 23, 2023.