Document

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
(Mark One) 
x    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
¨    TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File Number: 001-38593
Establishment Labs Holdings Inc.
(Exact name of Registrant as specified in its charter)
British Virgin Islands

 
Not applicable
State or Other Jurisdiction of
Incorporation or Organization
 
I.R.S. Employer Identification No.
 
 
 
Building B15 and 25
Coyol Free Zone
Alajuela
Costa Rica
 
Not applicable
Address of Principal Executive Offices
 
Zip Code

 
 
+506 2434 2400
 
 
Registrant’s Telephone Number, Including Area Code

 
 
 
 
 
 
 
Not applicable
 
 
Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report
 
 
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.  Yes ¨    No x
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).  Yes ¨    No x
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer ¨
 
Accelerated filer ¨
Non-accelerated filer x
 
Smaller reporting company ¨
Emerging growth company x
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.  ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).  Yes ¨    No x
The number of the registrant’s common shares outstanding as of August 14, 2018 was 20,471,340.



TABLE OF CONTENTS
 
 
Page
 
 
 
 



i


EXPLANATORY NOTE
In this report, unless the context indicates otherwise, the terms “Establishment Labs,” “Company,” “we”, “us” and “our” refer to Establishment Labs Holdings Inc., a British Virgin Islands entity, and its consolidated subsidiaries.
We own or have rights to trademarks and trade names that we use in connection with the operation of our business, including Establishment Labs and our logo as well as other brands such as Motiva Implants, SilkSurface/SmoothSilk, VelvetSurface, ProgressiveGel, TrueMonobloc, BluSeal, Divina, Ergonomix and MotivaImagine, among others. Other trademarks and trade names appearing in this report are the property of their respective owners. Solely for your convenience, some of the trademarks and trade names referred to in this report are listed without the ® and TM symbols, but we will assert, to the fullest extent under applicable law, our rights to our trademarks and trade names.

SPECIAL NOTE ABOUT FORWARD-LOOKING STATEMENTS
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). You can find many (but not all) of these statements by looking for words such as “approximates,” “believes,” “expects,” “anticipates,” “estimates,” “intends,” “plans,” “would,” “may” or other similar expressions in this report. Any statements that refer to projections of our future financial or operating performance, anticipated trends in our business, our goals, strategies, focus and plans, and other characterizations of future events or circumstances, including statements expressing general optimism about future operating results, are forward-looking statements.
We claim the protection of the safe harbor contained in the Private Securities Litigation Reform Act of 1995. We caution investors that any forward-looking statements presented in this report, or that we may make orally or in writing from time to time, are expressions of our beliefs and expectations based on currently available information at the time such statements are made. Such statements are based on assumptions, and the actual outcome will be affected by known and unknown risks, trends, uncertainties and factors that are beyond our control. Although we believe that our assumptions are reasonable, they are not guarantees of future performance, and some will inevitably prove to be incorrect. As a result, our actual future results may differ from our expectations, and those differences may be material.
Factors that could cause or contribute to these differences include, among others, those risks and uncertainties discussed under the sections contained in this Form 10-Q entitled “Part I, Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations,” “Part I, Item 3. Quantitative and Qualitative Disclosures about Market Risk,” and “Part II, Item 1A. Risk Factors”, and our other filings with the Securities and Exchange Commission. The risks included in those documents are not exhaustive, and additional factors could adversely affect our business and financial performance. We operate in a very competitive and rapidly changing environment. New risk factors emerge from time to time, and it is not possible for us to predict all such risk factors, nor can we assess the impact of all such risk factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
We are not undertaking any obligation to update any forward-looking statements. Accordingly, investors should use caution in relying on past forward-looking statements, which are based on known results and trends at the time they are made, to anticipate future results or trends.

1


PART I. - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
ESTABLISHMENT LABS HOLDINGS INC.
Condensed Consolidated Balance Sheets
(In thousands, except share data)
(Unaudited)
 
 
 
 
 
June 30,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash
$
11,642

 
$
10,864

Accounts receivable, net of allowance for doubtful accounts of $1,447 and $1,512
16,204

 
13,108

Inventory
13,223

 
13,173

Prepaid expenses and other current assets
4,273

 
2,237

Total current assets
45,342

 
39,382

Long-term assets:
 
 
 
Property and equipment, net of accumulated depreciation of $4,219 and $3,179
13,241

 
13,500

Goodwill
465

 
465

Intangible assets, net of accumulated amortization of $880 and $573
3,129

 
3,401

Restricted cash
75

 
75

Other non-current assets
1,071

 
272

Total assets
$
63,323

 
$
57,095

Liabilities and shareholders’ equity (deficit)
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
7,471

 
$
9,131

Accrued liabilities
4,900

 
2,326

Notes payable related party, including accrued interest
5,068

 
4,921

Note payable, Madryn, net of debt discount and issuance costs

 
19,167

Madryn put option

 
20,302

Madryn call option

 
360

Other liabilities, short term
1,333

 
1,228

Total current liabilities
18,772

 
57,435

Long-term liabilities:
 
 
 
Note payable, Madryn, net of debt discount and issuance costs
20,682

 

Madryn put option
16,105

 

Madryn call option
32

 

Other liabilities, long term
5,361

 
4,673

Total liabilities
60,952

 
62,108

Commitments and contingencies (Note 7)
 
 
 
Shareholders’ equity (deficit):
 
 
 
Ordinary shares - $1.00 par value (class A and B), 21,206,630 shares authorized at June 30, 2018 and December 31, 2017; 13,631,041 and 13,427,536 shares issued at June 30, 2018 and December 31, 2017, respectively; 12,409,831 and 12,206,326 shares outstanding at June 30, 2018 and December 31, 2017, respectively
13,631

 
13,427

Ordinary shares - no par value (class C, D, E, F, G and G-1), 4,191,169 and 2,316,169 shares authorized at June 30, 2018 and December 31, 2017, respectively; 3,327,343 and 2,316,169 shares issued and outstanding at June 30, 2018 and December 31, 2017, respectively
44,019

 
27,840

Common shares - $1.00 par value, 84,050,000 shares authorized at June 30, 2018 and December 31, 2017; zero shares issued and outstanding at June 30, 2018 and December 31, 2017

 

Additional paid-in-capital
30,354

 
27,986

Treasury shares, at cost, 1,221,210 shares held at June 30, 2018 and December 31, 2017
(6,465
)
 
(6,465
)
Accumulated deficit
(79,767
)
 
(67,877
)
Accumulated other comprehensive income
599

 
76

Total shareholders’ equity (deficit)
2,371

 
(5,013
)
Total liabilities and shareholders’ equity (deficit)
$
63,323

 
$
57,095

 
 
 
 

The accompanying notes are an integral part of these condensed consolidated financial statements.

2

Table of Contents
ESTABLISHMENT LABS HOLDINGS INC.
Condensed Consolidated Statements of Operations
(In thousands, except share and per share data)
(Unaudited)

 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
Revenue
 
$
13,709

 
$
8,627

 
$
28,525

 
$
15,546

Cost of revenue
 
5,492

 
4,502

 
12,393

 
8,011

Gross profit
 
8,217

 
4,125

 
16,132

 
7,535

Operating expenses:
 
 
 
 
 
 
 
 
Sales, general and administrative
 
10,829

 
8,126

 
19,477

 
13,975

Research and development
 
3,705

 
1,481

 
5,852

 
2,984

Total operating expenses
 
14,534

 
9,607

 
25,329

 
16,959

Loss from operations
 
(6,317
)
 
(5,482
)
 
(9,197
)
 
(9,424
)
Interest income
 

 
4

 
4

 
6

Interest expense
 
(2,173
)
 
(1,014
)
 
(4,344
)
 
(1,941
)
Change in fair value of derivative instruments
 
5,830

 
(3,913
)
 
4,525

 
(4,199
)
Change in fair value of contingent consideration
 
(389
)
 

 
(752
)
 

Initial public offering expenses
 

 
(1,585
)
 

 
(1,585
)
Other income (expense), net
 
(2,159
)
 
(101
)
 
(1,964
)
 
58

Loss before income taxes
 
(5,208
)
 
(12,091
)
 
(11,728
)
 
(17,085
)
Provision for income taxes
 
(152
)
 

 
(162
)
 
(5
)
Net loss
 
$
(5,360
)
 
$
(12,091
)
 
$
(11,890
)
 
$
(17,090
)
 
 
 
 
 
 
 
 
 
Basic and diluted net loss per share
 
$
(0.35
)
 
$
(1.55
)
 
$
(0.79
)
 
$
(2.37
)
Weighted average outstanding ordinary shares used for net loss per share
 
15,351,899

 
7,820,854

 
14,981,070

 
7,216,291

 
 
 
 
 
 
 
 
 


The accompanying notes are an integral part of these condensed consolidated financial statements.

3


ESTABLISHMENT LABS HOLDINGS INC.
Condensed Consolidated Statements of Comprehensive Loss
(In thousands)
(Unaudited)

 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
Net loss
$
(5,360
)
 
$
(12,091
)
 
$
(11,890
)
 
$
(17,090
)
Other comprehensive income:
 
 
 
 
 
 
 
Foreign currency translation gain
529

 
20

 
523

 
12

Other comprehensive gain
529

 
20

 
523

 
12

Comprehensive loss
$
(4,831
)
 
$
(12,071
)
 
$
(11,367
)
 
$
(17,078
)
 
 
 
 
 
 
 
 

The accompanying notes are an integral part of these condensed consolidated financial statements.

4

Table of Contents
ESTABLISHMENT LABS HOLDINGS INC.
Condensed Consolidated Statements of Cash Flows
(In thousands)
(Unaudited)

 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(11,890
)
 
$
(17,090
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
1,345

 
797

Provision for doubtful accounts
 
(65
)
 
325

Stock-based compensation
 
2,213

 
1,822

Write off of deferred offering costs
 

 
1,585

Change in fair value of derivative instruments
 
(4,525
)
 
4,199

Change in fair value of contingent consideration
 
752

 

Non-cash interest expense and amortization of debt discount
 
1,663

 
1,158

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
(3,660
)
 
(477
)
Inventory
 
(1,007
)
 
(2,299
)
Prepaid expenses and other current assets
 
(1,417
)
 
(1,288
)
Other assets
 
(799
)
 
(564
)
Accounts payable
 
(487
)
 
(5,577
)
Accrued liabilities
 
2,694

 
1,982

Other liabilities
 
273

 
630

Net cash used in operating activities
 
(14,910
)
 
(14,797
)
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(698
)
 
(1,016
)
Cost incurred for intangible assets
 
(34
)
 

Increase in restricted cash
 

 
96

Net cash used in investing activities
 
(732
)
 
(920
)
Cash flows from financing activities:
 
 
 
 
Borrowings on short-term notes payable
 

 
1,000

Repayments on short term notes payable
 

 
(1,200
)
Payments of deferred offering costs
 
(81
)
 
(290
)
Repayments on capital leases
 
(153
)
 
(80
)
Proceeds from issuance of ordinary shares, net of issuance costs
 
16,102

 
18,314

Proceeds from stock option exercises
 
436

 

Shares repurchased
 

 
(1,653
)
Net cash provided by financing activities
 
16,304

 
16,091

Effect of exchange rate changes on cash
 
116

 
108

Net increase in cash
 
778

 
482

Cash at beginning of period
 
10,864

 
479

Cash at end of period
 
$
11,642

 
$
961

 
 
 
 
 
Supplemental disclosures:
 
 
 
 
Cash paid for interest
 
$
2,630

 
$
921

Cash paid for income taxes
 
$
89

 
$
37

 
 
 
 
 
Supplemental disclosures of non-cash investing and financing activities:
 
 
 
 
Unpaid balance for property and equipment
 
$
898

 
$
801

Assets acquired under capital leases
 
$
50

 
$
52

Extinguishment of warrants with related party
 
$

 
$
958

Unpaid deferred offering costs
 
$
719

 
$

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

5

Table of Contents
ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)


1.    Formation and Business of the Company
Formation and Business of the Company
Establishment Labs Holdings Inc. and its wholly owned subsidiaries (collectively “the Company”, “we”, “us”, or “our”) is a global company that manufactures and markets innovative medical devices for aesthetic plastic surgery, reconstructive plastic surgery, and aesthetic dermatology. The Company was established in the British Virgin Islands on October 9, 2013, at which time Establishment Labs, S.A., the Costa Rican manufacturing company, was reincorporated as a wholly-owned subsidiary. The Company also has wholly-owned subsidiaries in the United States (JAMM Technologies, Inc. and Motiva USA LLC), Belgium (European Distribution Center Motiva BVBA), Brazil (Establishment Labs Produtos para Saude Ltda), France (Motiva Implants France SAS), Sweden (Motiva Nordica AB) and Switzerland (JEN-Vault AG). Substantially all of the Company’s revenues are derived from the sale of silicone breast implants under the brand of Motiva Implants.
The main manufacturing activities are conducted in two manufacturing facilities in Costa Rica. Beginning in 2010, the Company began operating under the Costa Rica free zone regime (Régimen de Zona Franca), which provides for reduced income tax and other tax obligations pursuant to an agreement with the Costa Rican authorities.
The Company’s products are approved for sale in Europe, the Middle East, Latin America, and Asia. The Company sells its products internationally through a combination of distributors and direct sales to customers.
The Company is pursuing regulatory approval to commercialize its products in the United States. The Company received approval of an investigational device exemption, or IDE, from the U.S. Food and Drug Administration, or FDA, in March 2018 to initiate the Motiva Implant clinical trial in the United States. Enrollment is anticipated to be completed in early 2019.
The Company has been expanding its global operations through a series of acquisitions. In November 2015, the Company purchased certain assets from Magna Equities I, LLC and established its wholly-owned subsidiary, JAMM Technologies, Inc., in the United States. In January 2016, the Company purchased a distribution company in Brazil to support the application to sell its products in Brazil. In March 2016, the Company purchased a storage and distribution company in Belgium to support its continued growth in Europe. In September 2016, the Company purchased a distribution company in France and established a wholly-owned subsidiary in Switzerland. In November 2017, the Company acquired certain assets from Femiline AB and established its wholly-owned subsidiary in Sweden, Motiva Nordica AB.
On July 23, 2018, the Company completed its initial public offering, or IPO, whereby it sold a total of 4,272,568 shares of common stock at $18.00 per share including 557,291 shares sold to underwriters for the exercise of their option to purchase additional shares. The Company received net proceeds from the IPO of approximately $71.5 million, after deducting underwriting discounts and commissions of $5.4 million.
Liquidity and Management’s Plan
In accordance with Accounting Standards Update, or ASU, No. 2014-15, Presentation of Financial Statements – Going Concern (Subtopic 205-40), the Company’s management evaluates whether there are conditions or events, considered in the aggregate, that raise substantial doubt about the Company’s ability to continue as a going concern within one year after the date that the financial statements are issued.
Although it is difficult to predict the Company’s liquidity requirements, as of June 30, 2018, and based upon the Company’s current operating plan and July 2018 IPO, the Company believes that it will have sufficient cash to meet its projected operating requirements for at least the next 12 months following the issuance of the interim condensed consolidated financial statements based on the balance of cash and the IPO proceeds. As of June 30, 2018, the Company had cash of $11.6 million. During the six months ended June 30, 2018, the Company incurred a net loss of $11.9 million and used $14.9 million of cash in operations. At June 30, 2018, the Company had an accumulated deficit of $79.8 million and currently does not expect to experience positive cash flows from operations in the near future as it continues expanding the organization to support planned sales growth while also continuing to invest in research and development of the Company’s products, clinical trials to enable regulatory approval in the United States, and other commercialization efforts. We also expect to incur significant additional expenditures as a public company.

6

Table of Contents
ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

2.    Summary of Significant Accounting Policies
There have been no material changes to the Company’s significant accounting policies during the six months ended June 30, 2018, as compared to the significant accounting policies described in Note 2 of the “Notes to Consolidated Financial Statements” in the Company’s audited consolidated financial statements as of December 31, 2017 and 2016 and for the years then ended. Below are those policies with current period updates.
Basis of Presentation and Consolidation
The accompanying condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP, and the applicable rules and regulations of the Securities and Exchange Commission, or SEC, for interim financial information. Accordingly, they do not include all of the information and notes required by GAAP for complete financial statements. The condensed consolidated balance sheet at June 30, 2018 has been derived from the audited consolidated financial statements at that date, but does not include all disclosures, including notes, required by GAAP for complete financial statements.
The accompanying condensed consolidated financial statements and related financial information should be read in conjunction with the audited consolidated financial statements and the related notes thereto for the years ended December 31, 2017 and 2016 presented in the Company’s prospectus dated July 18, 2018, or the Prospectus, filed pursuant to Rule 424(b) on July 20, 2018, with the U.S. Securities and Exchange Commission.
The condensed consolidated financial statements include the Company’s accounts and those of its wholly owned subsidiaries as of June 30, 2018 as follows:
 
 
Subsidiary
Incorporation/Acquisition Date
Establishment Labs, S.A. (Costa Rica)
January 18, 2004
Motiva USA, LLC (USA)
February 20, 2014
JAMM Technologies, Inc. (USA)
October 27, 2015
Establishment Labs Produtos par Saude Ltda (Brazil)
January 4, 2016
European Distribution Center Motiva BVBA (Belgium)
March 4, 2016
Motiva Implants France SAS (France)
September 12, 2016
JEN-Vault AG (Switzerland)
November 22, 2016
Motiva Nordica AB (Sweden)
November 2, 2017
 
 
All intercompany accounts and transactions have been eliminated in consolidation.
Unaudited Interim Condensed Consolidated Financial Information
The accompanying interim condensed consolidated financial statements as of June 30, 2018 and for the three and six months ended June 30, 2018 and 2017, and the related interim information contained within the notes to the condensed consolidated financial statements, are unaudited. The unaudited interim condensed consolidated financial statements have been prepared in accordance with GAAP and on the same basis as the audited consolidated financial statements. In the opinion of management, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments which are necessary to state fairly the Company’s financial position as of June 30, 2018, and the results of its operations and cash flows for the six months ended June 30, 2018 and 2017. Such adjustments are of a normal and recurring nature. The results for the three and six months ended June 30, 2018 are not necessarily indicative of the results to be expected for the full fiscal year 2018, or for any future period.
Segments
The chief operating decision maker for the Company is the Chief Executive Officer. The Chief Executive Officer reviews financial information presented on a consolidated basis, accompanied by information about revenue by

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Table of Contents
ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

geographic region, for purposes of allocating resources and evaluating financial performance. The Company has one business activity and there are no segment managers who are held accountable for operations, operating results or plans for levels or components below the consolidated unit level. Accordingly, the Company has determined that it has a single reportable and operating segment structure. The Company and its Chief Executive Officer evaluate performance based primarily on revenue in the geographic regions in which the Company operates.
Geographic Concentrations
The Company derives all of its revenues from sales to customers in Europe, the Middle East, Latin America, and Asia, and has not yet received approval to sell its products in the United States.
For the six months ended June 30, 2018, Brazil accounted for 14.6% of consolidated revenue, on a ship-to destination basis. For the six months ended June 30, 2017, no individual country exceeded 10% of consolidated revenue, on a ship-to destination basis.
The Company’s long-lived assets located in Costa Rica represented the majority of the total long-lived assets as of June 30, 2018 and December 31, 2017.
Use of Estimates
The preparation of financial statements in accordance with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the consolidated financial statements and accompanying notes. Significant accounting estimates and management judgments reflected in the consolidated condensed financial statements include items such as accounts receivable valuation and allowances, inventory valuation and allowances, valuation of acquired intangible assets, valuation of derivatives, estimation of assets’ useful lives and valuation of deferred income tax assets, including tax valuation allowances. Estimates are based on historical experience, where applicable, and other assumptions believed to be reasonable by management. Actual results may differ from those estimates under different assumptions or conditions.
Concentration of Credit Risk and Other Risks and Uncertainties
Financial instruments that potentially subject the Company to a concentration of credit risk consist principally of cash, restricted cash and accounts receivable. The majority of the Company’s cash is held at one financial institution in the United States. The Company has not experienced any losses on its deposits of cash.
All of the Company’s revenue has been derived from sales of its products in international markets, principally Europe, Middle East, Latin America, and Asia. In the international markets in which the Company participates, the Company uses a combination of distributors and makes direct sales to customers. The Company performs ongoing credit evaluations of its distributors and customers, does not require collateral, and maintains allowances for potential credit losses on customer accounts when deemed necessary.
During the six months ended June 30, 2018 and 2017, no customers accounted for more than 10% of the Company’s revenue. No customers accounted for more than 10% of the Company’s accounts receivable balance as of June 30, 2018 and December 31, 2017. Substantially all of the Company’s revenues are derived from the sale of Motiva Implants.
The Company relies on NuSil Technology, LLC, or NuSil, as the sole supplier of medical-grade silicone used in Motiva Implants as well as other products that are manufactured under contract to other customers. During the six months ended June 30, 2018 and 2017, the Company had purchases of $5.8 million, or 62.1% of total purchases, and $4.9 million, or 53.6% of total purchases, respectively, from Nusil. As of June 30, 2018 and December 31, 2017, we had an outstanding balance owed to this vendor of $0.2 million and $0.7 million, respectively.
The Company’s future results of operations involve a number of risks and uncertainties. Factors that could affect the Company’s future operating results and cause actual results to vary materially from expectations include, but are not limited to, uncertainty of regulatory approval of the Company’s current and potential future products, uncertainty of market acceptance of the Company’s products, competition from substitute products and larger companies, securing and protecting proprietary technology, strategic relationships and dependence on key individuals and sole source suppliers.

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Table of Contents
ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Products developed by the Company require clearances from the FDA or other international regulatory agencies prior to commercial sales. There can be no assurance that the products will receive the necessary clearances. If the Company was denied clearance, clearance was delayed, or the Company was unable to maintain its existing clearances, these developments could have a material adverse impact on the Company.
Cash
The Company’s cash consists of cash maintained in checking and interest-bearing accounts. The Company accounts for financial instruments with original maturities of three months or less at the date of purchase as cash equivalents. The Company held no cash equivalents as of June 30, 2018 and December 31, 2017.
Restricted Cash
As of June 30, 2018 and December 31, 2017, the restricted cash balance represented a certificate of deposit collateralizing payment of charges related to the Company's corporate credit card.
Accounts Receivable and Allowance for Doubtful Accounts
Accounts receivable is stated at invoice value less estimated allowances for returns and doubtful accounts. The Company continually monitors customer payments and maintains an allowance for estimated losses resulting from customers’ inability to make required payments. In evaluating the Company’s ability to collect outstanding receivable balances, the Company considers various factors including the age of the balance, the creditworthiness of the customer, which is assessed based on ongoing credit evaluations and payment history, and the customer’s current financial condition. In cases where there are circumstances that may impair a specific customer’s ability to meet its financial obligations, an allowance is recorded against amounts due, which reduces the net recognized receivable to the amount reasonably believed to be collectible. Historical returns of products have been de minimis and accordingly no allowance for returns was recorded as of June 30, 2018 and December 31, 2017.
Inventory and Cost of Revenue
Inventory is stated at the lower of cost to purchase or manufacture the inventory or the net realizable value of such inventory. Cost is determined using the standard cost method which approximates actual costs using the first-in, first-out basis. The Company regularly reviews inventory quantities considering actual losses, projected future demand, and remaining shelf life to record a provision for excess and slow-moving inventory. No inventory allowance has been recorded as of June 30, 2018 and December 31, 2017.
The Company recognizes the cost of inventory transferred to the customer in cost of revenue when revenue is recognized.
Shipping and Handling Costs
Shipping and handling costs are expensed as incurred and are included in selling, general and administrative, or SG&A, expenses. For the six months ended June 30, 2018 and 2017, shipping and handling costs were $0.8 million and $0.5 million, respectively. For the three months ended June 30, 2018 and 2017, shipping and handling costs were $0.5 million and $0.3 million, respectively.
Revenue Recognition
The Company recognizes revenue related to sales of products to distributors or directly to customers in markets where it has regulatory approval, net of trade discounts and allowances. The Company recognizes revenue in accordance with Accounting Standards Codification, or ASC, 605 Revenue Recognition when all of the following criteria are met:
persuasive evidence of an arrangement exists;
the sales price is fixed or determinable;
collection of the relevant receivable is probable at the time of sale; and
delivery has occurred or services have been rendered.
The Company recognizes revenue related to the sales of products to distributors at the time of shipment of the product, which represents the point in time when the customer has taken ownership and assumed the risk of loss

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

and the required revenue recognition criteria are satisfied. The Company’s distributors are obligated to pay within specified terms regardless of when, or if, they sell the products. The Company’s contracts with distributors typically do not contain right of return or price protection and have no post-delivery obligations.
Appropriate reserves are established for anticipated sales returns based on historical experience, recent gross sales and any notification of pending returns. The Company recognizes revenue when title to the product and risk of loss transfer to customers, provided there are no remaining performance obligations required of the Company or any written matters requiring customer acceptance. The Company allows for the return of product from direct customers in certain regions within fifteen days after the original sale and records estimated sales returns as a reduction of sales in the same period revenue is recognized. Sales return provisions are calculated based upon historical experience with actual returns. Actual sales returns in any future period are inherently uncertain and thus may differ from the estimates. If actual sales returns differ significantly from the estimates, an adjustment to revenue in the current or subsequent period is recorded. To date, sales returns have been de minimis. The Company will continue to monitor sales return activity and will record an allowance for sales returns against accounts receivable if deemed material.
A portion of the Company’s revenue is generated from the sale of consigned inventory maintained at physician, hospital, and clinic locations. For these products, revenue is recognized at the time the Company is notified by the consignee that the product has been implanted, not when the consigned products are delivered to the consignee’s warehouse.
The Company has a limited warranty to distributors for the shelf life of the product, which is five years from the time of manufacture. Estimated warranty obligations are recorded at the time of sale. The Company also offers a warranty to patients in the event of rupture and a replacement program for capsular contracture events provided certain registration requirements are met. Revenue for extended warranties are recognized ratably over the term of the agreement. To date, these warranty and program costs have been de minimis. The Company will continue to evaluate the warranty reserve policies for adequacy considering claims history.
Deferred revenue primarily consists of payments received in advance of meeting revenue recognition criteria. The Company has received payments from distributors to provide distribution exclusivity within a geographic area and recognizes deferred revenue on a ratable basis over the term of such contractual distribution relationship. Additionally, the Company has received payments from customers in direct markets prior to surgical implantation, and recognizes deferred revenue at the time the Company is notified by the customer that the product has been implanted. For all arrangements, any revenue that has been deferred and is expected to be recognized beyond one year is classified as long-term deferred revenue and included in “Other liabilities, long term” on the consolidated balance sheets.
Research and Development
Costs related to research and development, or R&D, activities are expensed as incurred. R&D costs primarily include personnel costs, materials, clinical expenses, regulatory expenses, product development, consulting services, outside research activities, all of which are directly related to research and development activities.
The Company estimates FDA clinical trial expenses based on the services performed, pursuant to contracts with research institutions and clinical research organizations that conduct and manage clinical trials on its behalf. In accruing service fees, the Company estimates the time period over which services will be performed and the level of patient enrollment and activity expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust the accrual accordingly.
Selling, General and Administrative Expenses
SG&A expenses include sales and marketing costs, payroll and related benefit costs, insurance expenses, shipping and handling costs, legal and professional fees and administrative overhead.
Property and Equipment
Property and equipment are stated at cost less accumulated depreciation and amortization.
Depreciation of property and equipment is computed using the straight-line method over the assets’ estimated useful lives of five to ten years. Leasehold improvements are amortized on a straight-line basis over the shorter of

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

the estimated useful life of the asset or the remaining lease term after factoring expected renewal periods. Upon retirement or disposal of assets, the costs and related accumulated depreciation are eliminated from the accounts and any gain or loss is recognized in operations. Maintenance and repairs are expensed as incurred. Substantially all of the Company’s manufacturing operations and related property and equipment is located in Costa Rica.
Goodwill and Intangible Assets
The Company records the excess of the acquisition purchase price over the net fair value of the tangible and identifiable intangible assets acquired and liabilities assumed as goodwill. In accordance with ASC 350, Intangibles - Goodwill and Other, the Company tests goodwill for impairment annually during the fourth quarter of each year and whenever events or changes in circumstances indicate that the carrying value of the asset may not be recoverable. In connection with the annual impairment test for goodwill, the Company elected the option to perform a qualitative assessment to determine whether it is more likely than not that the fair value of the reporting unit is less than its carrying amount. If the Company determines that it was more likely than not that the fair value of the reporting unit is less than its carrying amount, then the impairment test is performed.
Consistent with the Company's assessment that it has only one reporting segment, the Company has determined that it has only one reporting unit and tests goodwill for impairment at the entity level using the two-step process required by ASC 350. In the first step, the Company compares the carrying amount of the reporting unit to the fair value of the enterprise. If the fair value of the enterprise exceeds the carrying value, goodwill is not considered impaired and no further testing is required. If the carrying value of the enterprise exceeds the fair value, goodwill is potentially impaired, and the second step of the impairment test must be performed. In the second step, the Company compares the implied fair value of the goodwill, as defined by ASC 350, to its carrying amount to determine the impairment loss, if any.  
The Company capitalizes certain costs related to intangible assets, such as patents and trademarks and records purchased intangible assets at their respective estimated fair values at the date of acquisition. Purchased finite-lived intangible assets are being amortized using the straight-line method over their remaining estimated useful lives, which range from two to fifteen years. The Company evaluates the remaining useful lives of intangible assets on a periodic basis to determine whether events or circumstances warrant a revision to the remaining estimated amortization period. The Company tests indefinite-lived intangible assets for impairment on at least an annual basis and whenever circumstances suggest the assets may be impaired. If indicators of impairment are present, the Company evaluates the carrying value of the intangible assets in relation to estimates of future undiscounted cash flows. The Company also evaluates the remaining useful life of an indefinite-lived intangible asset to determine whether events and circumstances continue to support an indefinite useful life.
During the year ended December 31, 2017, there has been no impairment of goodwill or intangible assets based on the qualitative assessments performed by the Company. As of June 30, 2018, no triggering events have occurred which would indicate that the acquired intangible asset values may not be recoverable.
Long-Lived Assets
The Company reviews long-lived assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset might not be recoverable. When such an event occurs, management determines whether there has been impairment by comparing the anticipated undiscounted future net cash flows to the related asset group’s carrying value. If an asset is considered impaired, the asset is written down to fair value, which is determined based either on discounted cash flows or appraised value, depending on the nature of the asset. There were no impairment charges, or changes in estimated useful lives recorded during the year ended December 31, 2017. As of June 30, 2018, no triggering events have occurred which would indicate that the acquired intangible asset values may not be recoverable.
Debt and Embedded Derivatives
The Company applies the accounting standards for derivatives and hedging and for distinguishing liabilities from equity when accounting for hybrid contracts. The Company accounts for convertible debt instruments when the Company has determined that the embedded conversion options should not be bifurcated from their host instruments in accordance with ASC 470-20 Debt with Conversion and Other Options. The Company records,

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

when necessary, discounts to notes payable for the intrinsic value of conversion and other options embedded in debt instruments as a beneficial conversion option based upon the differences between the fair value of the underlying shares at the commitment date of the note transaction and the effective conversion price embedded in the note (see Note 6).
The Company uses option pricing valuation models to determine the fair value of embedded derivatives and records any change in fair value as a component of other income or expense in the consolidated statements of operations (see Note 5).
Debt Issuance Costs and Debt Discounts
Costs incurred in connection with the issuance of new debt are capitalized. Capitalizable debt issuance costs paid to third parties and debt discounts paid to creditors, net of amortization, are recorded as a reduction to the long-term debt balance on the consolidated balance sheets. Amortization expense on capitalized debt issuance costs and debt discounts related to loans are calculated using the effective interest method over the term of the loan commitment and is recorded as interest expense in the consolidated statements of operations.
Income Taxes
The Company records income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been recognized in the Company’s consolidated financial statements or income tax returns. In estimating future tax consequences, expected future events, enactments or changes in the tax law or rates are considered. Valuation allowances are provided when necessary to reduce deferred tax assets to the amount expected to be realized.
The Company operates in various tax jurisdictions and is subject to audit by various tax authorities.
The Company records uncertain tax positions based on a two-step process whereby (1) a determination is made as to whether it is more likely than not that the tax positions will be sustained based on the technical merits of the position and (2) for those tax positions that meet the more-likely-than-not recognition threshold the Company recognizes the largest amount of tax benefit that is greater than 50% likely to be realized upon ultimate settlement with the related tax authority. The Company’s policy is to recognize interest and penalties accrued on any unrecognized tax benefits as a component of income tax expense. Significant judgment is required in the identification of uncertain tax positions and in the estimation of penalties and interest on uncertain tax positions.
There were no material uncertain tax positions in fiscal 2017 and for the six months ended June 30, 2018.
Foreign Currency
The financial statements of the Company’s foreign subsidiaries whose functional currencies are the local currencies are translated into U.S. dollars for consolidation as follows: assets and liabilities at the exchange rate as of the balance sheet date, stockholders’ equity at the historical rates of exchange, and income and expense amounts at the average exchange rate for the period. Translation adjustments resulting from the translation of the subsidiaries’ accounts are included in “Accumulated other comprehensive income (loss).” Transactions denominated in currencies other than the applicable functional currency are converted to the functional currency at the exchange rate on the transaction date. At period end, monetary assets and liabilities are remeasured to the functional currency using exchange rates in effect at the balance sheet date. Non-monetary assets and liabilities are remeasured at historical exchange rates. Gains and losses resulting from foreign currency transactions are included within “Other income (expense), net.” For the six months ended June 30, 2018, foreign currency transaction loss amounted to $1.9 million as compared to a foreign currency transaction gain of $0.2 million for the six months ended June 30, 2017.
Deferred Offering Costs
Deferred offering costs, consisting of legal, accounting and other fees and costs relating to the Company’s IPO, are capitalized within “Other non-current assets” on the consolidated balance sheet. The deferred offering costs will be offset against the proceeds received upon the closing of the IPO. Due to a delayed IPO process beyond 90 days, the Company expensed the previously deferred offering costs of $1.6 million during the year ended December 31, 2017. In 2018, the Company resumed the IPO activities and capitalized $0.8 million of deferred offering costs as of June 30, 2018.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Comprehensive Income (Loss)
The Company’s comprehensive loss consists of net loss and foreign currency translation adjustments arising from the consolidation of the Company’s foreign subsidiaries.
Share-Based Compensation
The Company measures and recognizes compensation expense for all stock-based awards in accordance with the provisions of ASC 718, Stock Compensation. Stock-based awards granted include stock options and restricted stock awards, or RSAs. Share-based compensation expense for stock options and RSAs granted to employees is measured at the grant date based on the fair value of the awards and is recognized as an expense ratably on a straight-line basis over the requisite service period. The fair value of options to purchase ordinary shares granted to employees is estimated on the grant date using the Black-Scholes option valuation model.
The company accounts for stock options and RSAs issued to non-employees under ASC 505-50 Equity: Equity-Based Payments to Non-Employees, using the Black-Scholes option valuation model to value stock options. The fair value of such non-employee awards is remeasured at each quarter-end over the vesting period.
The calculation of share-based compensation expense requires that the company make assumptions and judgments about the variables used in the Black-Scholes model, including the expected term, expected volatility of the underlying common shares, risk-free interest rate and dividends.
The company adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, under which it recognizes forfeitures as they occur rather than applying a prospective forfeiture rate in advance (see Note 10).
Net Income (Loss) Per Share
Basic net income (loss) per ordinary share is calculated by dividing the net income (loss) attributable to ordinary shareholders by the weighted-average number of ordinary shares outstanding during the period, without consideration for potentially dilutive securities. Diluted net income (loss) per share is computed by dividing the net income (loss) attributable to ordinary shareholders by the weighted-average number of ordinary shares and potentially dilutive securities outstanding for the period. For purposes of the diluted net loss per share calculation, any shares issuable upon the conversion of convertible notes payable, share warrants and share options and non-vested restricted stock units outstanding under the Company’s equity plan are potentially dilutive securities. Because the Company has reported a net loss in all periods presented, diluted net loss per ordinary share is the same as basic net loss per ordinary share for those periods because including the dilutive securities would be anti-dilutive.
Recent Accounting Standards
Periodically, new accounting pronouncements are issued by the Financial Accounting Standards Board, or FASB, or other standard setting bodies and adopted by the Company as of the specified effective date. Unless otherwise discussed, the impact of recently issued standards that are not yet effective will not have a material impact on the Company’s consolidated financial statements upon adoption. Under the Jumpstart Our Business Startups Act of 2012, or JOBS Act, the Company meets the definition of an emerging growth company, and has elected the extended transition period for complying with new or revised accounting standards pursuant to Section 107(b) of the JOBS Act. The Company will remain an emerging growth company until the earliest of (1) the last day of its first fiscal year (a) following the fifth anniversary of the completion of our initial public offering, (b) in which we have total annual gross revenue of at least $1.07 billion, or (c) in which we are deemed to be a large accelerated filer, which means the market value of our common stock that is held by non-affiliates exceeds $700.0 million of the prior June 30th and (2) the date on which we have issued more than $1.0 billion in non-convertible debt securities during the prior three-year period.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The following recent accounting pronouncements issued by the FASB, could have a material effect on our financial statements:
Recently Adopted Accounting Standards
In May 2017, the FASB issued ASU 2017-09, Compensation - Stock Compensation (Topic 718): Scope of Modification Accounting. This ASU provides amendments to the current guidance on determining which changes to the terms and conditions of share-based payment awards require the application of modification accounting. The effects of a modification should be accounted for unless there are no changes between the fair value, vesting conditions, and classification of the modified award and the original award immediately before the original award is modified. ASU 2017-09 became effective for non-public business entities for annual periods, including interim periods within those annual periods, beginning after December 15, 2017. The adoption of this ASU did not have a material impact on the financial statements.
Recently Issued Accounting Standards
In June 2018, the FASB issued ASU 2018-07, Compensation – Stock Compensation (Topic 718), Improvements to Nonemployee Share-Based Payment Accounting. This ASU is intended to simplify aspects of share-based compensation issued to non-employees by making the guidance consistent with accounting for employee share-based compensation. This guidance is effective for non-public entities for fiscal years beginning after December 15, 2019, including interim periods within that fiscal year. Early adoption is permitted. The Company is currently in the process of evaluating the impact of this guidance on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which sets out the principles for the recognition, measurement, presentation and disclosure of leases for both parties to a contract (i.e. lessees and lessors). The new standard requires lessees to apply a dual approach, classifying leases as either finance or operating leases based on the principle of whether the lease is effectively a financed purchase by the lessee. This classification will determine whether lease expense is recognized based on an effective interest method or on a straight-line basis over the term of the lease, respectively. A lessee is also required to record a right-of-use asset and a lease liability for all leases with a term of greater than twelve months regardless of their classification. Leases with a term of twelve months or less will be accounted for similar to existing guidance for operating leases today. ASC 842 supersedes the previous leases standard, ASC 840 Leases. The standard is effective for non-public business entities for fiscal years beginning after December 15, 2018 and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted. The Company is currently evaluating the effects, if any, that the adoption of this guidance will have on its consolidated financial statements.
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers (Topic 606), which supersedes the revenue recognition requirements in ASC 605, Revenue Recognition. This ASU is based on the principle that revenue is recognized to depict the transfer of goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU also requires additional disclosure about the nature, amount, timing and uncertainty of revenue and cash flows arising from customer contracts, including significant judgments and changes in judgments and assets recognized from costs incurred to obtain or fulfill a contract. ASU 2014-09 provides two methods of retrospective application. The first method would require the Company to apply ASU 2014-09 to each prior reporting period presented. The second method would require the Company to retrospectively apply ASU 2014-09 with the cumulative effect recognized at the date of initial application. ASU 2014-09 is effective for non-public business entities beginning in fiscal 2019 as a result of ASU 2015-14, “Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date,” which was issued by the FASB in August 2015 and extended the original effective date by one year. In 2016, the FASB issued additional updates to the new revenue standard relating to reporting revenue on a gross versus net basis, identifying performance obligations and licensing arrangements, and narrow-scope improvements and practical expedients, respectively. The effective date of this additional update is the same as that of ASU 2014-09. The Company is currently evaluating the impact of adopting the available methodologies of ASU 2014-09 and the related updated revenue recognition guidance upon its financial statements in future reporting periods. The Company has not yet selected a transition method. The Company is in the process of evaluating the new standard against its existing accounting policies, including the timing of revenue recognition, and its contracts with customers to determine the effect the guidance will have on its financial statements and what changes to systems and controls may be warranted.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

3.     Balance Sheet Accounts
Inventory
 
 
 
 
 
 
 
June 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
(in thousands)
Raw materials
 
$
2,345

 
$
1,978

Work in process
 
513

 
1,132

Finished goods
 
10,365

 
10,063

 
 
$
13,223

 
$
13,173

 
 
 
 
 
Property and Equipment, Net
 
 
 
 
 
 
 
June 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
(in thousands)
Machinery and equipment
 
$
6,146

 
$
5,473

Vehicles
 
346

 
353

Furniture and fixtures
 
2,233

 
2,110

Leasehold improvements
 
8,735

 
8,743

Total
 
17,460

 
16,679

Less: Accumulated depreciation and amortization
 
(4,219
)
 
(3,179
)
 
 
$
13,241

 
$
13,500

 
 
 
 
 
For the six months ended June 30, 2018 and 2017, depreciation and amortization expense related to property and equipment was $1.1 million and $0.7 million, respectively.
The Company entered into capital leases relating to equipment and vehicles and recorded the fair value of the lease payments on the initial contract date, and is amortizing the assets over the term of the leases. As of June 30, 2018 and December 31, 2017, the gross asset value for capital lease assets was $1.4 million and $1.3 million, respectively. Depreciation expense for assets under capital leases has been de minimus.
In August 2015, the Company entered into a contract with the Zona Franca Coyol, S.A. to have them build a new manufacturing facility in Costa Rica. The construction of the new 27,900 square foot facility began in November 2015 and was finished during the first quarter of fiscal 2017. The construction costs were paid for by the Company. The Company has an option to purchase the title to the building for approximately $3.5 million and on May 11, 2016 the Company provided notice of the intent to exercise the purchase right and expects the transaction to complete by the end of 2018. Currently, the Company leases the building from Zona Franca Coyol, S.A. for approximately $28,000 per month.
4.     Goodwill and Other Intangible Assets
Goodwill represents the excess of the purchase price over the fair value of the net tangible and identifiable intangible assets acquired in a business combination. Intangible assets resulting from the acquisitions of entities accounted for using the acquisition method of accounting are recorded at the estimated fair value of the assets acquired. Purchased intangibles include certain patents and license rights, 510(k) authorization by the FDA to sell a medical device and other intangible assets.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Company’s goodwill and most intangibles at June 30, 2018 are the result of acquisitions of certain assets formerly owned by VeriTeQ Corporation in November 2015 and Femiline AB in November 2017 and business acquisitions of Establishment Labs Brasil Productos para Saude Ltda. in January 2016, European Distribution Center Motiva BVBA in March 2016 and Motiva Implants France in September 2016 (see Note 11). Finite-lived intangibles are amortized over their estimated useful lives based on expected future benefit.
In addition to the intangibles acquired, the Company capitalized certain patent and license rights as identified intangibles based on patent and license rights agreements entered into over the past several years. Additionally, the Company capitalized certain software development costs associated with its development of a manufacturing software module, which the Company began amortizing in fiscal 2017 upon implementation of the software.
There were no changes in the carrying amount of goodwill during the six months ended June 30, 2018:
 
 
 
 
 
 
 
 
 
Balance as of January 1, 2018
 
Additions
 
Accumulated Impairment Losses
 
Balance as of June 30, 2018
 
 
 
 
 
 
 
 
 
(in thousands)
Goodwill
$
465

 
$

 
$

 
$
465

 
 
 
 
 
 
 
 
Only goodwill related to the 2017 acquisition is deductible for tax purposes (see Note 11).
The carrying amounts of these intangible assets as of June 30, 2018 were as follows:
 
 
 
 
 
 
 
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Estimated Useful Lives
 
 
 
 
 
 
 
 
 
(in thousands)
 
(in years)
Patents and license rights
$
1,669

 
$
(459
)
 
$
1,210

 
7-12
Customer relationships
1,304

 
(202
)
 
1,102

 
10
510(k) authorization
567

 
(99
)
 
468

 
15
Developed technology
62

 
(31
)
 
31

 
10
Capitalized software development costs
98

 
(74
)
 
24

 
2
Other
17

 
(15
)
 
2

 
2-3
Capitalized patents and license rights not yet amortized
291

 

 
291

 
 
 
$
4,008

 
$
(880
)
 
$
3,128

 
 
 
 
 
 
 
 
 
 


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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The carrying amounts of intangible assets as of December 31, 2017 were as follows:
 
 
 
 
 
 
 
 
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Carrying Amount
 
Estimated Useful Lives
 
 
 
 
 
 
 
 
 
(in thousands)
 
(in years)
Patents and license rights
$
1,635

 
$
(361
)
 
$
1,274

 
7-12
Customer relationships
1,304

 
(40
)
 
1,264

 
10
510(k) authorization
567

 
(80
)
 
487

 
15
Developed technology
62

 
(28
)
 
34

 
10
Capitalized software development costs
98

 
(49
)
 
49

 
2
Other
17

 
(15
)
 
2

 
2-3
Capitalized patents and license rights not yet amortized
291

 

 
291

 
 
 
$
3,974

 
$
(573
)
 
$
3,401

 
 
 
 
 
 
 
 
 
 

The amortization expense associated with intangible assets was $0.3 million and $0.1 million for the six months ended June 30, 2018 and 2017, respectively. In fiscal 2018, non-product related amortization was recorded in SG&A while product related amortization was recorded in cost of revenue. In fiscal 2017, all amortization expense was recorded in cost of revenue as non-product related amortization was de minimus.
As of June 30, 2018, the amortization expense related to identifiable intangible assets, with definite useful lives, in future periods is expected to be as follows:
 
 
 
Year Ending December 31,
 
(in thousands)
2018 (remaining)
 
$
335

2019
 
551

2020
 
551

2021
 
511

2022
 
215

Thereafter
 
674

Total
 
$
2,837

 
 
 
The Company evaluates the recoverability of goodwill and indefinite-lived intangible assets annually and whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. As of June 30, 2018, no triggering events have occurred which would indicate that the acquired intangible asset values may not be recoverable.
5.    Fair Value Measurements
The carrying value of the Company’s cash, restricted cash, accounts receivable, accounts payable and short-term notes payable approximate fair value due to the short-term nature of these items. Based on the borrowing rates available to the Company for debt with similar terms and consideration of default and credit risk, the carrying value of the related-party notes payable approximates its fair value. Contingent equity consideration, warrants and put and call options that qualify for liability treatment are carried at fair value and re-measured at each reporting period.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Fair value is defined as the exchange price that would be received for an asset or an exit price paid to transfer a liability in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs.
The fair value hierarchy defines a three-level valuation hierarchy for disclosure of fair value measurements as follows:
Level I    Unadjusted quoted prices in active markets for identical assets or liabilities;
Level II    Inputs other than quoted prices included within Level I that are observable, unadjusted quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the related assets or liabilities; and
Level III    Unobservable inputs that are supported by little or no market activity for the related assets or liabilities.
The categorization of a financial instrument within the valuation hierarchy is based upon the lowest level of input that is significant to the fair value measurement.
The following table sets forth the Company’s financial instruments that were measured at fair value on a recurring basis by level within the fair value hierarchy at period end:
 
 
 
 
 
 
 
 
 
Fair Value Measurements at June 30, 2018
 
Total
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
(in thousands)
Liabilities
 
 
 
 
 
 
 
Madryn put option liability
$
16,105

 
$

 
$

 
$
16,105

Madryn call option liability
32

 

 

 
32

Acquisition-related contingent consideration
1,716

 

 

 
1,716

 
$
17,853

 
$

 
$

 
$
17,853

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Fair Value Measurements at December 31, 2017
 
Total
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
(in thousands)
Liabilities
 
 
 
 
 
 
 
Madryn put option liability
$
20,302

 
$

 
$

 
$
20,302

Madryn call option liability
360

 

 

 
360

Acquisition-related contingent consideration
964

 

 

 
964

 
$
21,626

 
$

 
$

 
$
21,626

 
 
 
 
 
 
 
 
The fair value measurement of derivatives and contingent consideration related to the business acquisition completed in fiscal 2017 is based on significant inputs not observed in the market and thus represents a Level 3 measurement.
In August 2017 the Company entered into a credit agreement, or the Madryn Credit Agreement, with Madryn Health Partners, LP, or Madryn, as administrative agent, and a syndicate of lenders (see Note 6). The Company determined that the Madryn Credit Agreement contained put options related to early redemption mandatory prepayment terms in case of change in control or an event of default and a call option related to voluntary

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

repayment option. The Company valued these put options and the call option and allocated a fair value of $15.1 million for these identified embedded derivatives as a debt discount on the original commitment date. An additional $5.0 million debt discount was recorded on respective borrowing dates when the Company met the required milestones and borrowed an additional $10.0 million in the fourth quarter of fiscal 2017. The Company revalued the options as of each reporting period and recorded the change in the fair value in the consolidated statement of operations as other income or expense.
Valuation of the embedded derivatives is complex and requires interest rate simulation, estimating the resultant bond valuation and the resultant pay-off to the option holder. The Company estimated the fair value of the embedded redemption options using the probability-weighted Binomial Lattice Model which is based on generalized binomial option pricing formula. The Binomial Option Pricing Model allows for the possibility of exercise before the end of the option’s life and considers future interest rates, volatility and other data with regards to the Company’s credit rating and credit spread. The probability of a change in control occurring was determined to be 60% at June 30, 2018 and 90% at December 31, 2017.
The Company used the following assumptions to value Madryn derivatives:
Put Option Liability (Madryn)
 
 
 
 
 
June 30, 2018
 
December 31,
2017
Interest rate volatility
18.7%
 
21.0%
Market yield rate
13.0%
 
12.5%
Term (in years)
5.0
 
5.5
Dividend yield
—%
 
—%
 
 
 
 
Call Option Liability (Madryn)
 
 
 
 
 
June 30, 2018
 
December 31,
2017
Interest rate volatility
18.7%
 
21.0%
Market yield rate
13.0%
 
12.5%
Term (in years)
5.0
 
5.5
Dividend yield
—%
 
—%
 
 
 
 
On November 17, 2017, the Company and Femiline AB and Johan Anderson, or the Seller, entered into an agreement to purchase certain assets from the Seller. The assets purchased included all existing inventory previously sold by the Company to the Seller, all customer relationships and a covenant not to compete. The aggregate purchase price for the assets purchased was 100,000 Class A Ordinary shares of the Company, contingently issuable upon achievement of specific milestones. Based on the valuation of the Company’s shares performed by a valuation specialist, the contingently issuable shares had an aggregate value of $1.0 million calculated as a product of contingently issuable shares and estimated fair value per share (see Note 11). As the ordinary shares are not publicly traded, the Company must estimate their fair value. The fair value of ordinary shares was determined on a periodic basis by the Company’s Board of Directors, with the assistance of an independent third-party valuation firm.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

In order to assess the fair value of our ordinary shares, our business enterprise value, or BEV, is determined and then allocated to each element of our capital structure (ordinary shares, warrants and options). Our BEV is estimated using the income approach and the market approach. The discounted cash flow method, or DCF, estimates the enterprise value based on the estimated present value of future net cash flows the business is expected to generate over a forecasted period and an estimate of the present value of cash flows beyond that period, which is referred to as terminal value. The estimated present value is calculated using a discount rate known as the weighted average cost of capital, which accounts for the time value of money and the appropriate degree of risks inherent in the business. Under the market approach, the enterprise value is based on the multiples of comparable companies and transactions. The BEV is allocated using probability-weighted expected return method, or PWERM, which estimates the fair value of common shares based on an analysis of future values for the enterprise assuming various future outcomes.
As of June 30, 2018 and December 31, 2017, the short term and long term portions of contingent consideration liability were included in “Other liabilities, short term” and “Other liabilities, long term”, respectively.
The estimates are based, in part, on subjective assumptions and could differ materially in the future.
During the periods presented, the Company has not changed the manner in which it values liabilities that are measured at fair value using Level 3 inputs. The Company recognizes transfers between levels of the fair value hierarchy as of the end of the reporting period. There were no transfers within the hierarchy during the six months ended June 30, 2018 or during the year ended December 31, 2017.
The fair value of the debt conversion feature liability includes the estimated volatility and risk-free rate.  The higher/lower the estimated volatility, the higher/lower the value of the debt conversion feature liability. The higher/lower the risk-free interest rate, the higher/lower the value of the debt conversion feature liability.
The following table sets forth a summary of the changes in the fair value of the Company’s Level 3 financial instruments as follows:
 
 
 
 
 
 
 
 
 
Warrant
Liability
 
Acquisition-related Contingent Consideration
 
Put Option Liability (Madryn)
 
Call Option Liability (Madryn)
Balance at December 31, 2016
$
3,983

 
$

 
$

 
$

Change in fair value
888

 

 

 

De-recognition during period
(958
)
 

 

 

Balance at June 30, 2017
$
3,913

 
$

 
$

 
$

 
 
 
 
 
 
 
 
Balance at December 31, 2017
$

 
$
964

 
$
20,302

 
$
360

Change in fair value

 
752

 
(4,197
)
 
(328
)
Balance at June 30, 2018
$

 
$
1,716

 
$
16,105

 
$
32

 
 
 
 
 
 
 
 
6.    Debt
Notes Payable Related Party
In August 2015, the Company entered into agreements with all of the Class Z redeemable convertible preferred shareholders to exchange their outstanding shares and accumulated dividends for notes payable with a principal balance of $4.2 million. Per the original agreement, the notes bore interest at a simple rate of 7% per annum with the interest payments due annually starting March 30, 2017 and a note maturity date of March 31, 2020. Per agreement, as amended, the notes became due and payable on July 23, 2018 when the Company successfully completed the IPO. During the six months ended June 30, 2018 and 2017, the Company recorded interest

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

expense of $0.1 million, to accrue for interest due on the notes.
The Company recorded the notes on the balance sheet as follows:
 
 
 
 
 
 
 
June 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
(in thousands)
Principal
 
$
4,218

 
$
4,218

Accrued interest
 
850

 
703

Total principal and accrued interest at end of period
 
$
5,068

 
$
4,921

 
 
 
 
 
The Company repaid the balance due, including accrued interest, in August 2018.
Related Party Convertible Notes Payable
In August 2015, the Company entered into a Note and Warrant Purchase Agreement, or the Note Agreement or the Notes, with CPH TU, LP, or CPH, a primary shareholder, to borrow up to $15.0 million. The Notes issued pursuant to the agreement bore interest at a simple rate of 10% per annum.
In January and July 2016, the Company amended the Note Agreement to increase the aggregate borrowing limit to $18.0 million and $19.8 million, respectively. In September 2016, the Company entered into an amended agreement with CPH to terminate the warrants originally issued in connection with the Notes, fix the conversion rate, and extend the maturity date.
In connection with the Notes, the Company issued warrants for the purchase of ordinary shares to CPH and to Rockport Ventures, the placement agent. The estimated fair value of the warrants issued in August 2015 was determined to be $1.1 million, which was recorded as a debt discount and was being amortized using the effective interest rate method over the term of the Notes (see Note 9).
The Company determined that the Note Agreement contained several put options related to liquidity events or an event of default. The Company valued these put options and allocated the fair value of $0.1 million for these identified embedded derivatives as a debt discount on the original commitment date in August 2015. The Company revalued the put options as of each reporting period and recorded the change in the fair value in the consolidated statement of operations as other income or expense (see Note 5).
August 2017 Conversion
On August 24, 2017, CPH elected to convert the principal and the accrued interest outstanding under the Notes into 5,869,417 shares of the Company’s Class B ordinary shares. The related beneficial conversion feature liability was amortized into non-cash interest expense while the CPH put option liability expired upon the conversion of the notes.
There was no outstanding balance under the Notes as of June 30, 2018 or December 31, 2017.
Madryn Debt
On August 24, 2017 the Company entered into a credit agreement, or the Madryn Credit Agreement, with Madryn Health Partners, LP, or Madryn, as administrative agent, and a syndicate of lenders. The Madryn Credit Agreement provides for a credit facility for a maximum principal amount of $55.0 million, $30.0 million (Term A) of which became available upon signing. The final maturity date under the Madryn Credit Agreement is June 30, 2023.
The availability of the additional Term B and Term C commitments under the Madryn Credit Agreement, which are for an aggregate principal amount of up to $25 million, are subject to the Company achieving certain revenue milestones. The Company met some of these milestones and borrowed an additional $5.0 million (Term B-1) on October 31, 2017 and $5.0 million (Term B-2) on December 15, 2017 bringing up the total outstanding principal balance to $40.0 million as of December 31, 2017. As of June 15, 2018, we were eligible to draw down an

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

additional $5.0 million (Term B-3) under the amended Credit Agreement, and an additional $10.0 million (Term C) may become available on or before June 30, 2020 if the required milestones for this tranche are achieved. The Company has not yet met the required milestones for the Term C tranche as of the date of the issuance of these interim financial statements. The availability of each tranche is also conditioned on the Company having advanced the maximum loan amount under each prior tranche.
In connection with the Madryn Credit Agreement, the Company and certain of its subsidiaries, granted a security interest in substantially all of the property of the Company and certain of its subsidiaries, including, without limitation, intellectual property, and pledges of certain shares of the Brazilian subsidiary and the Belgian subsidiary, subject to certain excluded collateral exceptions.
Borrowings under the Madryn Credit Agreement bear interest at a rate equal to 3-month LIBOR plus 11.0% per annum provided that no default has occurred. In an event of a default, the interest would increase by an additional 4.0% per annum. The weighted average interest rate under the credit agreement was approximately 13.3% at June 30, 2018. The Company incurred $2.6 million in interest expense in connection with Madryn Credit Agreement during the six months ended June 30, 2018 and $1.4 million in fiscal 2017. No principal payments are due until 2021. Eight quarterly payments of 12.5% of the principal amounts borrowed under each tranche are due beginning September 30, 2021 and each quarter end through and including June 30, 2023.
The Company also determined that the Madryn Credit Agreement contained put options which are mandatory repayment provisions related to liquidity events or an event of default and a call option related to voluntary repayment option. The Company valued these put options and the call option and allocated a fair value of $15.1 million for these identified embedded derivatives as a debt discount on the original commitment date in August 2017. An additional $5.0 million debt discount was recorded on respective borrowing dates when the Company met the required milestones and borrowed an additional $10.0 million in the fourth quarter of fiscal 2017. The Company revalues the options as of each reporting period and records the change in the fair value in the consolidated statement of operations as other income or expense (see Note 5). The Company also incurred legal expenses of $1.3 million in the third quarter of fiscal 2017, which were recorded as a debt discount and are being amortized over the term of the Madryn Credit Agreement.
The Madryn Credit Agreement contains customary affirmative and negative covenants, including, but not limited to, restrictions on the ability to incur additional indebtedness, create liens, make certain investments, make restricted payments, enter into or undertake certain liquidations, mergers, consolidations or acquisitions and dispose of assets or subsidiaries. In addition, the Madryn Credit Agreement requires the Company to maintain minimum revenues and liquidity.
In January 2018, management made an assessment that the Company would potentially technically default on the Madryn Credit Agreement due to its investment in our Brazilian subsidiary approaching the $5.0 million limit. The Company informed Madryn and the syndicate of lenders, or the Lenders, of the potential technical default event and started the process to obtain a forbearance agreement. The Company initially defaulted on the Madryn Credit Agreement on January 19, 2018 when it failed to put a Qualifying Control Agreement in place for certain bank deposit accounts and subsequently on February 28, 2018 when its investment in its Brazilian subsidiary exceeded the allowable $5.0 million threshold permitted under the Madryn Credit Agreement. Accordingly, the Company recorded the Madryn debt as a current liability on the consolidated balance sheet as of December 31, 2017. Effective June 15, 2018, Madryn Credit Agreement was amended to remove the restrictive covenants that resulted in the technical defaults which allowed the Company to reclassify the arrangement as long-term as of June 30, 2018.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The Company recorded Madryn debt on the balance sheet as follows:
 
 
 
 
 
June 30,
2018
 
December 31,
2017
 
 
 
 
 
(in thousands)
Principal
$
40,000

 
$
40,000

Accrued interest

 

Total principal and accrued interest at end of period
40,000

 
40,000

Net unamortized debt discount and issuance costs
(19,318
)
 
(20,833
)
Net carrying value of Madryn debt
$
20,682

 
$
19,167

 
 
 
 
The Company granted Madryn the right to purchase up to $2.0 million of shares issued by the Company in the next succeeding eligible equity investment in the Company. The Company has completed qualified financings during the first half of 2018, and Madryn chose not to exercise their right to purchase shares in those financings. Under this agreement, to the extent the Company redeems or repurchases any shares from any holder, the Company shall offer to resell one half of the repurchased shares to Madryn at the same price paid by the Company to purchase or retire the shares. The Company has completed qualified financings during the first half of 2018 and also completed its IPO in July 2018; Madryn chose not to exercise their right to purchase shares in those financings.
As of June 30, 2018, the Company is in compliance with all debt covenants.
7.     Commitments and Contingencies
Operating Leases
We lease certain facilities under various operating leases. Most of the lease agreements provide us with the option of renewing our leases at the end of the initial lease term, at fair market rates. In most cases, we expect that in the normal course of business, facility leases will be renewed or replaced by other leases.
For the six months ended June 30, 2018 and 2017, rent expense was $0.5 million and $0.4 million, respectively. For the three months ended June 30, 2018 and 2017, rent expense was $0.3 million and $0.2 million, respectively.
On May 18, 2018, the Company’s wholly-owned subsidiary in Belgium entered into a lease agreement for an office rental for an approximate annual base lease amount of approximately $0.2 million per year for a duration of nine years.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Future minimum lease payments under the operating leases as of June 30, 2018 were as follows:
 
 
 
Years Ending December 31,
 
Operating
Leases
 
 
(in thousands)
2018 (remaining)
 
$
466

2019
 
884

2020
 
884

2021
 
823

2022
 
851

Thereafter
 
4,038

 
 
$
7,946

 
 
 
Capital Lease
The Company entered into capital lease arrangements relating to software, equipment and vehicles. The lease periods are from one to seven years. The repayments are made monthly with an interest rates ranging from 4% to 7% per year.
Future minimum lease payments under these capital leases as of June 30, 2018 were as follows:
 
 
 
Years Ending December 31,
 
Capital
Leases
 
 
(in thousands)
2018 (remaining)
 
$
172

2019
 
333

2020
 
243

2021
 
139

2022
 
37

Thereafter
 

 
 
924

Interest included in the above payments
 
(106
)
Amount payable without interest
 
818

Short-term minimum capital lease payments (included in accrued liabilities)
 
324

Long-term minimum capital lease payments
 
$
494

 
 
 
Contingencies
Periodically, the Company may have certain contingent liabilities that arise in the ordinary course of business activities. The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. There have been no contingent liabilities requiring accrual or disclosure at June 30, 2018 and December 31, 2017.
Indemnification
The Company enters into standard indemnification arrangements in the ordinary course of business. Pursuant to these arrangements, the Company indemnifies, holds harmless, and agrees to reimburse the indemnified parties for losses suffered or incurred by the indemnified party, in connection with any trade secret, copyright, patent or other intellectual property infringement claim by any third-party with respect to the Company’s technology. The

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

term of these indemnification agreements is generally perpetual. The maximum potential amount of future payments the Company could be required to make under these agreements is not determinable because it involves claims that may be made against the Company in the future, but have not yet been made.
The Company has entered into indemnification agreements with its directors and officers that may require the Company to indemnify its directors and officers against liabilities that may arise by reason of their status or service as directors or officers, other than liabilities arising from willful misconduct of the individual.
The Company has not incurred costs to defend lawsuits or settle claims related to these indemnification agreements. No liability associated with such indemnifications has been recorded to date.
8.    Shareholders’ Equity (Deficit)
General
Under the Memorandum of Association and Articles of Association, or Articles, in effect as of December 31, 2017, the Company had authorized 84,050,000 common shares with a par value of $1.00 per share, 13,482,782 Class A ordinary shares with a par value of $1.00 per share, 7,723,848 Class B ordinary shares with a par value of $1.00 per share, 96,301 Class C ordinary shares with no par value, 1,539,359 Class D ordinary shares with no par value, 323,366 Class E ordinary shares with no par value and 357,143 Class F ordinary shares with no par value. During the first half of 2018, the Company amended its Articles to authorize 1,250,000 Class G and 625,000 Class G-1 ordinary shares with no par value.
In connection with the IPO in July 2018, all outstanding ordinary shares were converted into common shares.
Common Shares
No common shares have been issued as of June 30, 2018.
Ordinary Shares
As of June 30, 2018 and December 31, 2017, 16,958,384 and 15,743,705 shares, respectively, of ordinary shares were issued and 15,737,174 and 14,522,495 shares, respectively, were outstanding.
Class A and B
As of June 30, 2018 and December 31, 2017, 13,631,041 and 13,427,536 shares, respectively, of ordinary Class A and Class B shares were issued and 12,409,831 and 12,206,326 shares, respectively, were outstanding. Class A and Class B ordinary shares have a par value of $1.00 per share.
During the six months ended June 30, 2018, the Company issued restricted stock awards to employees and contractors. The Company records the awards as outstanding equity as they vest (see Note 10).
Ordinary Class A and B shares have the following rights:
Voting Rights. Each holder of the Company’s ordinary shares is entitled to one vote for each share on all matters submitted to a vote of the shareholders, including the election of directors.
Protective Provisions. As long as CPH TU, L.P. and its affiliates continue to hold at least 25% of the Class B Ordinary Shares, the Company cannot do the following without the consent of CPH TU, L.P.:
a.
liquidate, dissolve or wind-up the business and affairs of the Company, effect any merger or consolidation or any other Deemed Liquidation Event, as defined in the Articles, or consent to any of the foregoing;
b.
amend, alter or repeal any provision of the Articles;
c.
create, or authorize the creation of, or issue or obligate itself to issue shares of, any additional class or series of shares unless the same ranks junior to the Class G ordinary shares, Class F ordinary shares, Class E ordinary shares, Class D ordinary shares, Class C ordinary shares, Class B ordinary shares and the Class A ordinary shares of the Company (with respect to the distribution of assets on the liquidation, dissolution or winding up of the Company, the payment of dividends and rights of redemption, or increase the authorized number of ordinary shares);

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

d.
create, or authorize the creation of, or issue, or authorize the issuance of any debt security, or permit any subsidiary to take any such action with respect to any debt security, if the aggregate indebtedness of the Company and its subsidiaries for borrowed money following such action would exceed $500,000, including any debt security issued for the financing of the construction or purchase of a new production facility, unless such debt security has received the prior approval of the Board of Directors, including at least one of the Investor Directors;
e.
create, or hold shares in any subsidiary that is not wholly owned (either directly or through one or more other subsidiaries) by the Company, or sell, transfer or otherwise dispose of any shares of any direct or indirect subsidiary of the Company, or permit any direct or indirect subsidiary to sell, lease, transfer, exclusively license or otherwise dispose (in a single transaction or series of related transactions) of all or substantially all of the assets of such subsidiary;
f.
encumber or grant a security interest in any of the Company’s property (tangible or intangible) or business;
g.
grant an exclusive license for, or create a negative pledge for, all or substantially all of the Company’s intellectual property assets;
h.
authorize a non pro-rata distribution;
i.
increase or decrease the authorized number of directors constituting the Board of Directors; or
j.
permit any subsidiary to do any of the foregoing.
Redemption. The ordinary shares may be redeemed by the Company at any time based on a resolution of the Board of Directors.
Dividends. Holders of the Company’s ordinary shares are entitled to receive dividends, if any, as may be declared from time to time by its Board of Directors out of legally available funds.
Liquidation. In the event of liquidation, dissolution or winding up, holders of its ordinary shares will be entitled to share ratably in the net assets legally available for distribution to shareholders after the payment of all of its debts and other liabilities.
Class C, D, E, F, G and G-1
As of June 30, 2018 and December 31, 2017, 3,327,343 and 2,316,169 shares, respectively, of ordinary Class C, D, E, F, G and G-1 shares were issued and outstanding. Class C, D, E, F, G and G-1 shares have no par value.
In multiple closings during the first six months ended June 30, 2018, the Company issued an aggregate of $6.2 million of Class G ordinary shares at a purchase price of $16.00 per share to several investors. In connection with the issuance of these shares, the Company amended and restated its Articles to increase the authorized shares of the Company to a total of 109,447,799 shares and to authorize 1,250,000 Class G and 625,000 Class G-1 shares.
In May 2018, the Company issued an aggregate of $10.0 million of Class G-1 ordinary shares at a purchase price of $16.00 per share to entities affiliated with RTW Investments.
The documents effecting the sale and issuance of these shares contained customary voting, registration, right of first refusal and co-sale rights.
Class C, D, E, F, G and G-1 ordinary shares have the following rights:
Voting Rights. Each holder of the Company’s ordinary shares is entitled to one vote for each share on all matters submitted to a vote of the shareholders provided the holders of each class vote together with the holders of other classes of ordinary shares and not as a separate class.
Protective Provisions. As long as any Class D ordinary shares remain outstanding, the Company cannot (1) amend the preferences, rights or privileges of the Class D ordinary shares or (2) pay or declare a dividend or distribution without the consent of the holders of a majority of the Class D ordinary shares.
Redemption. The ordinary shares may be redeemed by the Company at any time based on a resolution of the

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Board of Directors.
Dividends. Holders of the Company’s ordinary shares are entitled to receive dividends, if any, as may be declared from time to time by its Board of Directors out of legally available funds.
Liquidation. In the event of liquidation, dissolution or winding up, holders of its ordinary shares will be entitled to share ratably in the net assets legally available for distribution to shareholders after the payment of all of its debts and other liabilities.
The Company had reserved ordinary shares for future issuances as follows:
 
 
 
 
 
June 30,
2018
 
December 31,
2017
Warrants to purchase ordinary shares
145,000

 
145,000

Options to purchase ordinary shares
965,443

 
863,932

Remaining shares available under the 2015 Equity Incentive Plan
228,118

 
91,181

Shares issuable on vesting of restricted stock awards
461,598

 
585,056

Total
1,800,159

 
1,685,169

 
 
 
 
In January 2018, the Company increased the number of Class A shares reserved for 2015 Equity Incentive Plan by 400,000 shares to a new total of 2,650,000 shares.
9.    Warrants
In connection with the Notes issued to CPH in August 2015, the Company agreed to issue warrants to purchase ordinary shares to CPH and to Rockport Ventures, the placement agent for the Notes.
In March 2017, the Rockport Warrants were canceled and new warrants for the purchase of 145,000 Class B ordinary shares were issued to parties related to Rockport Ventures, with a fixed exercise price of $3.80 per share.
During the first half of 2017, the Company classified the fair value of these warrants as liabilities on the balance sheet due to the existence of certain cash settlement features that are not within the sole control of the Company and variable settlement provision that cause them to not be indexed to the Company’s own shares.
The value of the CPH warrants was estimated using the Black-Scholes valuation model which approximates a Lattice valuation model, and at issuance, the Company initially recorded the fair value of the warrants as a debt discount against the related loan balance in its consolidated balance sheet. The recorded value of the warrants is being amortized to interest expense over the estimated repayment term of the related loans. The value of the Rockport Ventures warrants was estimated using the Black Sholes valuation model which approximates a Lattice valuation model, and at issuance, the Company initially recorded the fair value of the warrants as a debt offering cost against the related loan balance in its balance sheet. The recorded value of the warrants is being amortized to interest expense using the straight-line method over the term of the related loans.
As of June 30, 2018 and December 31, 2017, the 145,000 warrants to purchase ordinary shares were outstanding and exercisable:
 
 
 
 
 
 
 
 
 
 
 
 
 
Warrant Holder
 
Issue Date
 
In Connection With
 
Warrant to
Purchase
 
Shares
 
Exercise
Price
 
Expiration Date
Rockport
 
3/3/2017
 
Loan agreement
 
Ordinary
 
145,000

 
$
3.80

 
8/28/2022
 
 
 
 
 
 
 
 
 
 
 
 
 

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

In July 2017, the Company early adopted ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities From Equity (Topic 480); Derivatives And Hedging (Topic 815): (Part I) Accounting For Certain Financial Instruments With Down Round Features, (Part Ii) Replacement Of The Indefinite Deferral For Mandatorily Redeemable Financial Instruments Of Certain Nonpublic Entities And Certain Mandatorily Redeemable Noncontrolling Interests With A Scope Exception. As a result, certain warrants that were previously classified as a liability due to an existence of down round features became qualified to be classified as equity. The adoption of this standard resulted in $1.0 million reclassification of warrant liability into additional paid in capital as of July 1, 2017.
10.     Share-Based Compensation
In December 2015, the Board of Directors approved and adopted the 2015 Equity Incentive Plan, or 2015 Plan. Under the 2015 Plan, the Company may grant share options, equity appreciation rights, and restricted shares and restricted share units. Pursuant to the 2015 Plan, the Company has granted RSAs and stock options to Board of Directors, employees and consultants.
The 2015 Plan, as amended, reserves 2,650,000 Class A shares for issuance. If an award granted under the 2015 Plan expires, terminates, is unexercised, or is forfeited, or if any shares are surrendered in connection with an incentive award, the shares subject to such award and the surrendered shares become available for further awards under the 2015 Plan.
Concurrent with the closing of the IPO, the Board of Directors terminated the 2015 Equity Plan and replaced it with the 2018 Equity Incentive Plan, or the 2018 Plan, with an initial reserve of 1,500,000 shares of the Company’s common shares for issuance under the 2018 Plan.
During the periods presented, the Company recorded the following share-based compensation expense for stock options and restricted stock awards:
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
 
 
(in thousands)
Sales, general and administrative
 
$
484

 
$
265

 
$
586

 
$
635

Research and development
 
986

 
435

 
1,627

 
1,187

Total
 
$
1,470

 
$
700

 
$
2,213

 
$
1,822

 
 
 
 
 
 
 
 
 
Stock Options
 
 
 
 
 
 
 
 
 
 
 
Number of Options Outstanding
 
Weighted-Average Exercise Price
 
Weighted-Average Remaining Contractual Term (in years)
 
Aggregate Intrinsic Value (in thousands)
Balances at December 31, 2017
 
863,932

 
$
5.36

 
7.6
 
$
4,199

Granted (weighted-average fair value of $6.47 per share)
 
329,628

 
10.19

 
 
 
 
Exercised
 
(106,248
)
 
4.11

 
 
 
 
Forfeited/canceled
 
(40,364
)
 
6.58

 
 
 
 
Balances at June 30, 2018
 
1,046,948

 
$
6.96

 
8.6
 
$
10,676

 
 
 
 
 
 
 
 
 

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

As of June 30, 2018, 364,156 options were vested and exercisable with weighted-average exercise price of $4.39 per share and a total aggregate intrinsic value of $4.6 million.
During the six months ended June 30, 2018, 106,248 options were exercised at a price of $4.11 per share. The intrinsic value of the options exercised during the six months ended June 30, 2018 and 2017 was $1.4 million and zero, respectively. Upon the exercise of stock options, the Company issued new Class A ordinary shares from its authorized shares. There were no exercises of stock options during the year ended December 31, 2017.
At June 30, 2018, unrecognized compensation expense was $1.9 million related to stock options granted to employees and Board of Directors and $1.6 million related to stock options granted to consultants. The weighted-average period over which such compensation expense will be recognized is 3.0 years.
Stock Options Granted to Employees
Share-based compensation expense for employees is based on the grant date fair value. The Company recognizes compensation expense for all share-based awards on a straight-line basis over the requisite service period of the awards, which is generally the vesting term of four years. During the six months ended June 30, 2018 and 2017, the Company recognized $0.3 million and $39,000, respectively, of stock-based compensation expense for stock options granted to employees.
The Company uses the Black-Scholes option valuation model to value options granted to employees and consultants, which requires the use of highly subjective assumptions to determine the fair value of share-based awards. The assumptions used in the Company’s option-pricing model represent management’s best estimates. These estimates are complex, involve a number of variables, uncertainties and assumptions and the application of management’s judgment. If factors change and different assumptions are used, the Company’s share-based compensation expense could be materially different in the future. The assumptions and estimates that the Company uses in the Black-Scholes model are as follows:
Fair Value of Common Shares. As the ordinary shares are not publicly traded, the Company must estimate their fair value. The fair value of ordinary shares was determined on a periodic basis by the Company’s Board of Directors, with the assistance of an independent third-party valuation firm.  The Board of Directors intended all options granted to be exercisable at a price per share not less than the estimated per share fair value of the shares underlying those options on the date of grant.
Risk-Free Interest Rate. The Company bases the risk-free interest rate used in the Black-Scholes valuation model on the implied yield available on U.S. Treasury zero-coupon issues with a term equivalent to that of the term of the options for each option group on the measurement date.
Term. For employee stock options, the expected term represents the period that the Company’s share-based awards are expected to be outstanding. Because of the limitations on the sale or transfer of the Company’s shares as a privately held company, the Company does not believe its historical exercise pattern is indicative of the pattern it will experience as a publicly traded company. The Company has consequently used the Staff Accounting Bulletin 110, or SAB 110, simplified method to calculate the expected term of employee stock options, which is the average of the contractual term and vesting period. The Company plans to continue to use the SAB 110 simplified method until it has sufficient trading history as a publicly traded company. For consultant stock options, the term used is equal to the remaining contractual term on the measurement date.
Volatility. The Company determines the price volatility based on the historical volatilities of industry peers as it has no trading history for its shares. Industry peers consist of several public companies in the medical device industry with comparable characteristics, including revenue growth, operating model and working capital requirements. The Company intends to continue to consistently apply this process using the same or a similar peer group of public companies until a sufficient amount of historical information regarding the volatility of its own shares becomes available, or unless circumstances change such that the identified peer companies are no longer similar, in which case other suitable peer companies whose common share prices are publicly available would be utilized in the calculation. The volatility is calculated based on the term on the measurement date.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Dividend Yield. The expected dividend assumption is based on the Company’s current expectations about its anticipated dividend policy. The Company has no expectation that it will declare dividends on its ordinary shares, and therefore has used an expected dividend yield of zero.
The fair value of stock options granted to employees in 2018 was estimated using the following assumptions:
 
 
 
 
 
Six Months Ended June 30,
 
 
2018
Volatility
 
57%
Risk-free interest rate
 
2.7% - 2.9%
Term (in years)
 
6.25
Dividend yield
 
0%
 
 
 
The Company did not grant any stock options to employees during 2017.
Stock Options Granted to Non-Employees
Stock-based compensation expense related to stock options granted to non-employees is recognized as the stock options are earned using an accelerated attribution method. The Company believes that the estimated fair value of the stock options is more readily measurable than the fair value of the services rendered. For the six months ended June 30, 2018 and 2017, the Company recognized expense of $1.2 million and $0.6 million for stock options granted to consultants.
The fair value of stock options granted to consultants was estimated using the following assumptions during the following periods presented:
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Volatility
 
58.0% - 59.0%
 
43.0%
Risk-free interest rate
 
2.8%
 
2.3%
Term (in years)
 
10.0
 
9.5 - 9.8
Dividend yield
 
0.0%
 
0.0%
 
 
 
 
 
Restricted Stock Awards
Each vested RSA entitles the holder to be issued one share of Class A ordinary shares. Restricted stock awards vest according to a vesting schedule determined by the Compensation Committee of the Company’s Board of Directors, generally over a one to four year period.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The following table represents RSA activity for fiscal 2018:
 
 
 
 
 
 
 
Restricted Stock Awards
 
Weighted-
Average
Grant Date
Fair Value
Outstanding unvested at December 31, 2017
 
585,056

 
$
7.57

Granted
 
90,301

 
13.27

Vested
 
(97,257
)
 
6.12

Forfeited/canceled
 
(116,502
)
 
9.60

Outstanding unvested at June 30, 2018
 
461,598

 
$
8.47

 
 
 
 
 
The fair value of RSAs is the grant date market value of the Class A ordinary shares. The Company recognizes share-based compensation expense related to RSAs using a straight-line method over the vesting term of the awards. The fair value of RSAs that vested during the six months ended June 30, 2018 and 2017, was $0.6 million and $1.1 million, which was calculated based on the market value of the Company’s ordinary shares on the applicable date of vesting.
As of June 30, 2018, we had unrecognized share-based compensation cost of approximately $5.1 million associated with unvested restricted stock awards. This cost is expected to be recognized over a weighted-average period of approximately 2.2 years.
11.    Business Combinations
On November 17, 2017, the Company and Femiline AB and Johan Anderson, or the Seller, entered into an agreement to purchase certain assets from the Seller. The assets purchased included all existing inventory previously sold by the Company to the Seller, all customer relationships and a covenant not to compete. The aggregate purchase price for the assets purchased was 100,000 Class A Ordinary shares of the Company, contingently issuable upon achievement of specific milestones. Based on the valuation of the Company’s shares performed by a valuation specialist, the contingently issuable shares had an aggregate value of $1.0 million. The book value of the inventory at the time of the acquisition was approximately $0.7 million, which was revalued on the transaction date to be the estimated selling price less the cost to sell, which increased the fair value of the inventory to approximately $1.5 million.
Concurrently, the Company entered into a Separation Agreement with Novaform Ltd, or Novaform, and Pantelis Ioannou. In April 2015, Novaform had become a distributor for Establishment Labs S.A., wholly-owned subsidiary of the Company and subsequently sublicensed its distribution rights to Femiline AB. Under the Separation Agreement, Novaform agreed to relinquish the distribution rights back to the Company for $1.0 million in cash and 35,714 Class A ordinary shares. Based on the valuation of the Company’s shares performed by a valuation specialist, the fair value of the shares issued was $0.3 million.
This transaction enabled the Company to realign its existing distribution network in Sweden, Denmark and Norway and initiate direct sales to customers in the region.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

The purchase price and allocation of purchase price were as follows:
 
 
 
Purchase Price:
 
(in thousands)
Cash consideration
 
$
1,000

Fair market value of Class A ordinary shares issued
 
344

Contingent consideration
 
964

Cash paid for inventory
 
704

Total purchase price
 
$
3,012

 
 
 
 
 
 
Allocation of Purchase Price:
 
(in thousands)
Inventory
 
$
1,498

Customer relationships
 
1,280

Covenant not to compete
 
24

Goodwill
 
210

Total purchase price allocated
 
$
3,012

 
 
 
As of December 31, 2017, the consideration of $1.0 million to Novaform and $0.7 million to Femiline AB has not been paid and is included in “Accounts payable”. As of June 30, 2018, the consideration of $0.4 million to Novaform was still outstanding.
Only the goodwill related to the 2017 acquisition is deductible for tax purposes.
12.    Net Income (Loss) Per Share
The following table summarizes the computation of basic and diluted net loss per share for the periods presented:
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(in thousands, except share and per share data)
Numerator:
 
 
 
 
 
 
 
Net loss
$
(5,360
)
 
$
(12,091
)
 
$
(11,890
)
 
$
(17,090
)
Denominator:


 
 
 


 
 
Weighted average ordinary shares
15,351,899

 
7,820,854

 
14,981,070

 
7,216,291

Net loss per share, basic and diluted
$
(0.35
)
 
$
(1.55
)
 
$
(0.79
)
 
$
(2.37
)
 
 
 
 
 
 
 
 
Basic net loss per share is computed by dividing the net loss by the weighted-average number of ordinary shares outstanding for the period. Diluted net loss per share is computed by dividing the net loss by the weighted-average number of ordinary shares and dilutive ordinary share equivalents outstanding for the period, determined using the treasury-share method and the as-if converted method, for convertible securities, if inclusion of these is dilutive.
Because the Company has reported a net loss in all periods presented, diluted net loss per ordinary share is the same as basic net loss per ordinary share for those periods because including the dilutive securities would be

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

anti-dilutive.
The following potentially dilutive securities outstanding at the end of the periods presented have been excluded from the computation of diluted shares:
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
2018
 
2017
Shares issuable on conversion of related party convertible notes payable
 

 
5,869,417

Options to purchase ordinary shares
 
965,443

 
786,503

Shares issuable on vesting of restricted stock awards
 
461,598

 
614,052

Warrants to purchase ordinary shares
 
145,000

 
145,000

Total
 
1,572,041

 
7,414,972

 
 
 
 
 
13.    Related Party Transactions
In August 2015, the Company entered into a Note and Warrant purchase agreement with CPH (see Note 6). On August 24, 2017, CPH elected to convert the principal and the accrued interest outstanding under the Notes into 5,869,417 shares of the Company’s Class B ordinary shares. There was no outstanding balance under the Note and Warrant purchase agreement as of December 31, 2017. CPH owns approximately 47.8% of the ordinary shares of the Company as of June 30, 2018.
In January 2017, the Company issued secured promissory notes to Mr. Chacón Quirós, the Company’s Chief Executive Officer and director, and to Crown Predator Holdings, LLC, a related party, in an aggregate principal amount of $1.2 million under existing note purchase, security and pledge agreements. These promissory notes were repaid by the Company in January 2017 and April 2017.
In August 2017, the Company entered into a credit agreement with Madryn and a syndicate of lenders to borrow up to $55.0 million (see Note 6). As of June 30, 2018, Madryn owns approximately 4.7% of the ordinary shares of the Company.
In August 2015, the Company entered into a Note Agreement with the former Class Z preferred shareholders to exchange the outstanding shares for notes payable in the aggregate principal amount of $4.3 million. The notes became due and payable on July 23, 2018 when the Company successfully completed the IPO. The Company repaid the balance due, including accrued interest, in August 2018 (see Note 6). The Class Z preferred shareholders were primarily the original founders of the Company.
During the six months ended June 30, 2018 and 2017, the Company recorded revenue of $0.4 million and $0.3 million, respectively, for product sales to Herramientas Medicas, S.A., a distribution company owned by a family member of the Chief Executive Officer of the Company. Accounts receivable owed to the Company from this distribution company amounted to approximately $0.1 million and $0.3 million as of June 30, 2018 and December 31, 2017, respectively.
In December 2016, the Company entered into a note agreement to borrow $0.2 million from executive officer of the Company. This note was repaid in 2017.
In September 2016, the Company entered into a share repurchase agreement with Global Silicone SRL for the repurchase of 813,140 ordinary shares of the Company owned by Global Silicone SRL in exchange for $3.7 million. In October 2016, the Company paid $2.0 million to Global Silicone SRL to repurchase 440,040 shares and the remaining $1.7 million was paid in April 2017. In July 2017, the Company paid $2.8 million to repurchase additional 406,570 Class A ordinary shares from Global Silicone SRL.
In May 2016, the Company entered into a scientific board advisory agreement with Dr. Manuel Enrique Chacón Quirós pursuant to which Dr. Chacón Quirós joined the Company’s Scientific Advisory Board, provides general scientific advice, and serves as a clinical investigator, among other services. In exchange for these services, Dr.

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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

Chacón Quirós was granted options to purchase 20,580 shares, vesting over four years in equal annual installments, provided that he continues to provide these services at such times. In September 2016, the Company entered into a separate agreement whereby Dr. Chacón Quirós will maintain his clinic in Costa Rica as a MotivaImagine Excellence Center and will host and train physicians in the use of the Company products in relevant procedures, among other services, in exchange for cash reimbursement of up to $4,500 per day that such services are rendered. Dr. Chacón Quirós is the brother of our Chief Executive Officer, Juan José Chacón Quirós. During the six months ended June 30, 2018 and 2017, the Company paid Dr. Chacón Quirós approximately $42,000 and $33,500, respectively, for services rendered.
During the six months ended June 30, 2018, the Company recorded revenue of approximately $40,000 for product sales to Motiva Netherlands BV, a distribution company owned by Erick Vogelanzeng, our Vice President of Sales, Europe. There were no accounts payable due to this distribution company at June 30, 2018 and December 31, 2017.
14.    Subsequent Events
The Company has reviewed and evaluated subsequent events that occurred through August 14, 2018.
On July 23, 2018, the Company completed its IPO whereby it sold a total of 4,272,568 shares of common stock at $18.00 per share including 557,291 shares sold to underwriters for the exercise of their option to purchase additional shares. The Company received net proceeds from the IPO of approximately $71.5 million, after deducting underwriting discounts and commissions of $5.4 million.
Concurrent with the closing of the IPO, the following transactions were completed in accordance with the related agreements:
the Company amended and restated its Articles to automatically convert all outstanding classes of the Company’s stock into common shares of a single class of no par value. An unlimited number of common shares was authorized.
The Board of Directors terminated the 2015 Equity Plan and replaced it with the 2018 Equity Incentive Plan with an initial reserve of 1,500,000 shares of the Company’s common shares for issuance under the 2018 Plan;
The Board of Directors adopted the 2018 Employee Share Purchase Plan, or the ESPP, with an initial reserve of 100,000 shares of the Company’s common shares for issuance under the 2018 Plan.
On August 3, 2018, the Company repaid the balance due, including accrued interest, on the notes payable to related parties. The notes became due and payable on July 23, 2018 when the Company successfully completed the IPO.
Between July 1, 2018 and August 14, 2018, the Board of Directors approved grants of 467,852 shares of stock options under the 2018 Plan.
Compensation for Named Executive Officers
On August 10, 2018, the Board of Directors, upon recommendation of its Compensation Committee, or the Committee, and in consultation with the Company’s independent compensation consultant, Radford, approved various compensation arrangements for the Company’s named executive officers, or the NEOs.
The Committee approved new base salary and bonus opportunity targets for fiscal year 2018 for the NEOs.  The table below sets forth the annual base salary and annual target bonus for the NEOs that will become effective subject to each NEO entering into a new employment agreement, which is approved by the Committee and executed by each NEO.  Renee Gaeta, Chief Financial Officer, executed her agreement with the Company on August 10, 2018. The bonus amounts will be determined based upon achievement of a mix of Company and individual performance objectives pursuant to the Company’s Executive Incentive Compensation Plan. 


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ESTABLISHMENT LABS HOLDINGS, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

 
 
 
 
 
 
 
Name
 
Title
 
Annual Base Salary for Fiscal Year 2018
 
Annual Target Bonus for Fiscal Year 2018
Juan José Chacón Quirós

 
Chief Executive Officer and Director
 
$400,000
 
$260,000
Renee Gaeta
 
Chief Financial Officer
 
$315,000
 
$157,500
 
 
 
 
 
 
 
Compensation for Non-Employee Directors
The Compensation Committee undertook an analysis similar to that for the executive officers with respect to evaluating the compensation of the Company’s non-employee directors.  As a result of such analysis, upon the recommendation of the Committee, and in consultation with Radford, the Board of Directors approved an increase to the annual non-employee director option grants under the Director Compensation Plan to an annual option grant to purchase 10,000 common shares.


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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
You should read the following discussion and analysis of our financial condition and results of operations together with the condensed consolidated financial statements and related notes that are included elsewhere in this Quarterly Report on Form 10-Q and our final prospectus dated July 18, 2018, or the Prospectus, related to the Company’s initial public offering, or IPO, filed with the Securities and Exchange Commission, or the SEC, on July 20, 2018 pursuant to Rule 424(b) under the Securities Act of 1933, as amended (Reg. No. 333-225791). This discussion contains forward-looking statements based upon current expectations that involve risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors,” set forth in Part II, Item 1A of this Quarterly Report on Form 10-Q. See “Special Note Regarding Forward-Looking Statements” below.
Forward-Looking Statements
The information in this discussion contains forward-looking statements and information within the meaning of Section 27A of the Securities Act and Section 21E of the Exchange Act, which are subject to the “safe harbor” created by those sections. These forward-looking statements include, but are not limited to, statements concerning our strategy, future operations, future financial position, future revenues, projected costs, prospects and plans and objectives of management. The words “anticipates,” “believes,” “estimates,” “expects,” “intends,” “may,” “plans,” “projects,” “will,” “would” and similar expressions are intended to identify forward-looking statements, although not all forwardlooking statements contain these identifying words. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements and you should not place undue reliance on our forward-looking statements.
Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forwardlooking statements that we make. These forward-looking statements involve risks and uncertainties that could cause our actual results to differ materially from those in the forward-looking statements, including, without limitation, the risks set forth in Part II, Item 1A, “Risk Factors” in this Quarterly Report on Form 10-Q and in our other filings with the SEC. The forward-looking statements are applicable only as of the date on which they are made, and we do not assume any obligation to update any forward-looking statements.
Overview
We are a medical technology company focused on improving patient safety and aesthetic outcomes, initially in the breast aesthetics and reconstruction market. Our line of silicone gel-filled breast implants, branded as Motiva Implants, is the centerpiece of our MotivaImagine medical technology platform. Post-market surveillance data, which was not generated in connection with an the U.S. Food and Drug Administration, or FDA, PMA approval study and was self-collected rather than collected at mandatory follow-ups, and published third-party data indicates that Motiva Implants show low rates of adverse events (including rupture, capsular contracture, and safety related reoperations) that we believe compare favorably with those of our competitors. We believe the proprietary technologies that differentiate our Motiva Implants enable improved safety and aesthetic outcomes and have helped drive our revenue growth. Our MotivaImagine platform enables surgical techniques that we promote as Motiva branded surgeries. We have developed other complementary products and services on our MotivaImagine platform, which are aimed at further enhancing patient outcomes.
We have devoted a majority of our resources since inception to developing our Motiva Implants, which we began selling in October 2010. We have incurred net losses in each year since inception, and we have financed our operations primarily through private equity financings and debt financings.
Our revenue for the six months ended June 30, 2018 and 2017 was $28.5 million and $15.5 million, respectively, an increase of $13.0 million, or 83.5%. Net losses decreased to $11.9 million for the six months ended June 30, 2018 from $17.1 million for the six months ended June 30, 2017. As of June 30, 2018, we had an accumulated deficit of $79.8 million.
Our cash balance as of June 30, 2018 was $11.6 million.
On July 23, 2018, the Company completed its initial public offering, or IPO, whereby it sold a total of 4,272,568 shares of common stock at $18.00 per share including 557,291 shares sold to underwriters for the exercise of their option to purchase additional shares. The Company received net proceeds from the IPO of approximately $71.5 million, after deducting underwriting discounts and commissions of $5.4 million.

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We have made and continue to make significant investments in additional manufacturing capacity, marketing, customer service, and a direct sales force in certain territories like Brazil and several countries in Europe in order to drive and support further adoption of our Motiva Implants. We will continue to incur losses at least in the near term as we expand our organization to support planned sales growth, while also continuing to invest in research and development of our products, clinical trials to enable regulatory approval in the United States, and other commercialization efforts. We also expect to incur significant additional expenditures as a public company.
As a result of these and other factors, we expect to continue to incur net losses in the intermediate term and may need to raise additional capital through equity and debt financings in order to fund our operations. Our operating results may fluctuate on a quarterly or annual basis in the future, and our growth or operating results may not be consistent with predictions made by securities analysts, if any. If we are unable to achieve our revenue growth objectives, we may not be able to achieve profitability.
Components of Results of Operations
Revenue
We commenced sales of our Motiva Implants in October 2010 and these products have historically accounted for the majority of our revenues. Sales of our Motiva Implants accounted for over 80% of our revenues for the year ended December 31, 2017, and we expect our revenues to continue to be driven primarily by sales of these products. We primarily derive revenue from sales of our Motiva Implants to two types of customers: (1) medical distributors and (2) direct sales to physicians, hospitals, and clinics.
We recognize revenue related to the sales of products at the time of shipment, except for a portion of our direct sales revenue that is generated from the sale of consigned inventory maintained at physician, hospital, and clinic locations. For consignment sales, revenue is recognized at the time we are notified by the consignee that the product has been implanted. Our contracts with distributors do not typically contain right of return or price protection and have no post-delivery obligations.
We expect our revenue to increase as we enter new markets, expand awareness of our products in existing markets, and grow our distributor network and direct sales force. We also expect our revenue to fluctuate from quarter to quarter due to a variety of factors, including seasonal fluctuations in demand for Motiva Implants. We are also affected by foreign currency fluctuations, however, to date, the net impact of foreign currency translation has been insignificant.
Cost of Revenue and Gross Margin
Our implants are manufactured at our two facilities in Costa Rica, one of which opened in 2017. Cost of revenue is primarily the cost of silicone but also includes other raw materials, packaging, components, quality assurance, labor costs, as well as manufacturing and overhead expenses. Cost of revenue also includes depreciation expense for production equipment, and amortization of certain intangible assets.
We calculate gross margin as revenue less cost of revenue for a given period divided by revenue. Our gross margin may fluctuate from period to period depending, in part, on the efficiency and utilization of our manufacturing facilities, targeted pricing programs, and sales volume based on geography, customer and product type.
Operating Expenses
Sales, General and Administrative
Sales, general and administrative, or SG&A, expenses primarily consist of compensation, including salary, share-based compensation and employee benefits for our sales and marketing personnel, and for administrative personnel that support our general operations such as information technology, executive management, financial accounting, customer service, and human resources personnel. SG&A expenses also includes costs attributable to marketing, sales support, travel, legal services, financial audit fees, insurance costs, and consulting services. We expect to incur additional SG&A expenses in connection with our becoming a public company, which may increase further when we are no longer able to rely on the “emerging growth company” exemption we are afforded under the Jumpstart Our Business Startups Act of 2012, or JOBS Act.
We expect our SG&A expenses to continue to increase in absolute dollars for the foreseeable future as our business grows and we continue to invest in our sales, marketing, medical education, training and general administration resources to build our corporate infrastructure. However, we expect our SG&A expenses to

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decrease as a percentage of our revenue over the long term, although our SG&A expenses may fluctuate from period to period due to the timing of expenses related to our sales and marketing campaigns.
Research and Development
Our research and development, or R&D, activities primarily consist of engineering and research programs associated with our products under development, as well as R&D activities associated with our clinical development activities. Our R&D expenses primarily consist of compensation, including salary, share-based compensation and employee benefits for our R&D and clinical personnel. We also incur significant expenses for supplies, development prototypes, design and testing, clinical study costs and product regulatory and consulting expenses.
We expect our R&D expenses to continue to increase in absolute dollars and as a percentage of revenue for the foreseeable future as we continue to advance our products under development, as well as initiate and prepare for additional clinical studies. We received an approval of an investigational device exemption, or IDE, from the FDA in March 2018 to initiate a clinical trial and enrolled the first patient during the first half of 2018. We estimate that total costs for this PMA clinical trial will be between $30.0 million and $40.0 million over ten years. We also have other products under development for which we may be required to conduct clinical trials in future periods in order to receive regulatory approval to market these products.
Interest Expense
Interest expense consists primarily of cash and non-cash interest related to outstanding debt and amortization of debt discounts. As of June 30, 2018, we had $45.1 million in outstanding principal and accrued interest.
Change in Fair Value of Derivative Instruments
Change in fair value of derivative instruments consists of changes in the fair value of our share warrants and put and call option liabilities.
Other Income (Expense), Net
Other income (expense), net primarily consists foreign currency gains/losses, bank charges, interest income and change in fair value of contingent consideration.
Income Tax Expense
Income tax expense consists primarily of income taxes in foreign jurisdictions in which we conduct business. Due to our history of losses, we maintain a full valuation allowance for deferred tax assets including net operating loss carry-forwards, R&D tax credits, capitalized R&D and other book versus tax differences.

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Consolidated Results of Operations
The following tables set forth our results of operations for the periods presented, in dollars:
 
 
 
 
 
 
 
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2018
 
2017
 
2018
 
2017
 
 
 
 
 
 
 
 
 
(unaudited) (in thousands)
Revenue
$
13,709

 
$
8,627

 
$
28,525

 
$
15,546

Cost of revenue
5,492

 
4,502

 
12,393

 
8,011

Gross profit
8,217

 
4,125

 
16,132

 
7,535

Operating expenses:
 
 
 
 
 
 
 
Sales, general and administrative
10,829

 
8,126

 
19,477

 
13,975

Research and development
3,705

 
1,481

 
5,852

 
2,984

Total operating expenses
14,534

 
9,607

 
25,329

 
16,959

Loss from operations
(6,317
)
 
(5,482
)
 
(9,197
)
 
(9,424
)
Interest expense
(2,173
)
 
(1,014
)
 
(4,344
)
 
(1,941
)
Change in fair value of derivative instruments
5,830

 
(3,913
)
 
4,525

 
(4,199
)
Other income (expense), net
(2,548
)
 
(1,682
)
 
(2,712
)
 
(1,521
)
Loss before income taxes
(5,208
)
 
(12,091
)
 
(11,728
)
 
(17,085
)
Provision for income taxes
(152
)
 

 
(162
)
 
(5
)
Net loss
$
(5,360
)
 
$
(12,091
)
 
$
(11,890
)
 
$
(17,090
)
 
 
 
 
 
 
 
 

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Comparison of Three Months Ended June 30, 2018 and 2017
 
 
 
 
 
Three Months Ended June 30,
 
2018
 
2017
 
 
 
 
 
(in thousands)
Revenue
$
13,709

 
$
8,627

Cost of revenue
5,492

 
4,502

Gross profit
$
8,217

 
$
4,125

Gross margin
59.9