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 September 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 x    No ¨
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 x  No ¨
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 November 9, 2018 was 20,538,321.



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)
 
 
 
 
 
September 30,
2018
 
December 31,
2017
Assets
 
 
 
Current assets:
 
 
 
Cash
$
65,577

 
$
10,864

Accounts receivable, net of allowance for doubtful accounts of $1,488 and $1,512
18,248

 
13,108

Inventory
15,365

 
13,173

Prepaid expenses and other current assets
5,597

 
2,237

Total current assets
104,787

 
39,382

Long-term assets:
 
 
 
Property and equipment, net of accumulated depreciation of $4,637 and $3,179
12,892

 
13,500

Goodwill
465

 
465

Intangible assets, net of accumulated amortization of $1,038 and $573
2,970

 
3,401

Restricted cash
75

 
75

Other non-current assets
283

 
272

Total assets
$
121,472

 
$
57,095

Liabilities and shareholders’ equity (deficit)
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
5,492

 
$
9,131

Accrued liabilities
5,861

 
2,326

Notes payable related party, including accrued interest

 
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
3,498

 
1,228

Total current liabilities
14,851

 
57,435

Long-term liabilities:
 
 
 
Note payable, Madryn, net of debt discount and issuance costs
21,486

 

Madryn put option
4,717

 

Other liabilities, long term
3,431

 
4,673

Total liabilities
44,485

 
62,108

Commitments and contingencies (Note 7)

 

Shareholders’ equity (deficit):
 
 
 
Ordinary shares - $1.00 par value (class A and B), zero and 21,206,630 shares authorized at September 30, 2018 and December 31, 2017, respectively; zero and 13,427,536 shares issued at September 30, 2018 and December 31, 2017, respectively; zero and 12,206,326 shares outstanding at September 30, 2018 and December 31, 2017, respectively

 
13,427

Ordinary shares - no par value (class C, D, E, F, G and G-1), zero and 2,316,169 shares authorized at September 30, 2018 and December 31, 2017, respectively; zero and 2,316,169 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively

 
27,840

Common shares - zero par value, unlimited amount and 84,050,000 shares authorized at September 30, 2018 and December 31, 2017, respectively; 20,539,095 and zero shares issued at September 30, 2018 and December 31, 2017, respectively; 20,131,025 and zero shares outstanding at September 30, 2018 and December 31, 2017, respectively
144,612

 

Additional paid-in-capital
12,891

 
27,986

Treasury shares, at cost, 408,070 and 1,221,210 shares held at September 30, 2018 and December 31, 2017, respectively
(2,854
)
 
(6,465
)
Accumulated deficit
(78,461
)
 
(67,877
)
Accumulated other comprehensive income
799

 
76

Total shareholders’ equity (deficit)
76,987

 
(5,013
)
Total liabilities and shareholders’ equity (deficit)
$
121,472

 
$
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
September 30,
 
Nine Months Ended
September 30,
 
 
2018
 
2017
 
2018
 
2017
Revenue
 
$
16,286

 
$
7,324

 
$
44,811

 
$
22,870

Cost of revenue
 
6,173

 
3,720

 
18,566

 
11,731

Gross profit
 
10,113

 
3,604

 
26,245

 
11,139

Operating expenses:
 
 
 
 
 
 
 
 
Sales, general and administrative
 
12,985

 
8,139

 
32,462

 
22,114

Research and development
 
3,174

 
1,436

 
9,026

 
4,420

Total operating expenses
 
16,159

 
9,575

 
41,488

 
26,534

Loss from operations
 
(6,046
)
 
(5,971
)
 
(15,243
)
 
(15,395
)
Interest income
 
5

 
3

 
9

 
9

Interest expense
 
(2,204
)
 
(6,691
)
 
(6,548
)
 
(8,632
)
Change in fair value of derivative instruments
 
11,420

 
2,095

 
15,945

 
(2,104
)
Change in fair value of contingent consideration
 
(694
)
 

 
(1,446
)
 

Initial public offering expenses
 

 

 

 
(1,585
)
Other income (expense), net
 
(1,274
)
 
(79
)
 
(3,238
)
 
(21
)
Income (loss) before income taxes
 
1,207

 
(10,643
)
 
(10,521
)
 
(27,728
)
Benefit (provision) for income taxes
 
99

 
(31
)
 
(63
)
 
(36
)
Net income (loss)
 
$
1,306

 
$
(10,674
)
 
$
(10,584
)
 
$
(27,764
)
 
 
 
 
 
 
 
 
 
Basic net income (loss) per share
 
$
0.07

 
$
(1.21
)
 
$
(0.66
)
 
$
(3.15
)
Diluted net income (loss) per share
 
$
0.06

 
$
(1.21
)
 
$
(0.66
)
 
$
(3.15
)
Weighted average outstanding shares used for basic net income (loss) per share
 
19,152,995

 
8,824,807

 
16,146,675

 
8,824,807

Weighted average outstanding shares used for diluted net income (loss) per share
 
20,123,297

 
8,824,807

 
16,146,675

 
8,824,807

 
 
 
 
 
 
 
 
 


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

3


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

 
 
 
 
 
 
 
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2018
 
2017
 
2018
 
2017
Net income (loss)
$
1,306

 
$
(10,674
)
 
$
(10,584
)
 
$
(27,764
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation gain (loss)
200

 
(49
)
 
723

 
(37
)
Other comprehensive gain (loss)
200

 
(49
)
 
723

 
(37
)
Comprehensive income (loss)
$
1,506

 
$
(10,723
)
 
$
(9,861
)
 
$
(27,801
)
 
 
 
 
 
 
 
 

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

4

Table of Contents
ESTABLISHMENT LABS HOLDINGS INC.
Condensed Consolidated Statement of Shareholders’ Deficit
(Unaudited) (In thousands, except share data)


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Common Shares
 
Ordinary Shares
 
Treasury Shares
 
Additional
Paid-In
Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Income
 
Total
 
 
Shares
 
Amount
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance at January 1, 2018
 

 
$

 
15,743,705

 
$
41,267

 
(1,221,210
)
 
$
(6,465
)
 
$
27,986

 
$
(67,877
)
 
$
76

 
$
(5,013
)
Issuance of ordinary shares
 

 

 
100,615

 
1,610

 

 

 

 

 

 
1,610

Stock option exercises
 

 

 
106,248

 
106

 

 

 
330

 

 

 
436

Share-based compensation
 

 

 
42,025

 
42

 

 

 
701

 

 

 
743

Foreign currency translation gain (loss)
 

 

 

 

 

 

 

 

 
(6
)
 
(6
)
Net loss
 

 

 

 

 

 

 

 
(6,530
)
 

 
(6,530
)
Balances at March 31, 2018
 

 

 
15,992,593

 
43,025

 
(1,221,210
)
 
(6,465
)
 
29,017

 
(74,407
)
 
70

 
(8,760
)
Issuance of ordinary shares
 

 

 
910,559

 
14,570

 

 

 
(78
)
 

 

 
14,492

Stock option exercises
 

 

 

 

 

 

 

 

 

 

Share-based compensation
 

 

 
55,232

 
55

 

 

 
1,415

 

 

 
1,470

Foreign currency translation gain (loss)
 

 

 

 

 

 

 

 

 
529

 
529

Net loss
 

 

 

 

 

 

 

 
(5,360
)
 

 
(5,360
)
Balances at June 30, 2018
 

 

 
16,958,384

 
57,650

 
(1,221,210
)
 
(6,465
)
 
30,354

 
(79,767
)
 
599

 
2,371

Issuance of common shares, IPO
 
4,272,568

 
70,055

 

 

 

 

 

 

 

 
70,055

Stock option exercises
 
19,343

 
180

 

 

 

 

 

 

 

 
180

Warrant exercises
 
31,474

 
121

 

 

 

 

 

 

 

 
121

Share-based compensation
 

 

 
70,466

 
71

 

 

 
2,683

 

 

 
2,754

Retirement of treasury shares
 

 

 
(813,140
)
 
(813
)
 
813,140

 
3,611

 
(2,798
)
 

 

 

Conversion of ordinary shares to common shares
 
16,215,710

 
74,256

 
(16,215,710
)
 
(56,908
)
 

 

 
(17,348
)
 

 

 

Foreign currency translation gain (loss)
 

 

 

 

 

 

 

 

 
200

 
200

Net income
 

 

 

 

 

 

 

 
1,306

 

 
1,306

Balances at September 30, 2018
 
20,539,095

 
$
144,612

 

 
$

 
(408,070
)
 
$
(2,854
)
 
$
12,891

 
$
(78,461
)
 
$
799

 
$
76,987

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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

5

Table of Contents
ESTABLISHMENT LABS HOLDINGS INC.
Condensed Consolidated Statement of Shareholders’ Deficit
(Unaudited) (In thousands, except share data)


 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Ordinary Shares
 
Treasury Shares
 
Additional
Paid-In
Capital
 
Accumulated
Deficit
 
Accumulated Other Comprehensive Income
 
Total
 
 
Shares
 
Amount
 
Shares
 
Amount
 
 
 
 
Balance at January 1, 2017
 
7,118,753

 
$
7,118

 
(813,140
)
 
$
(3,611
)
 
$
3,038

 
$
(32,980
)
 
$

 
$
(26,435
)
Issuance of ordinary shares
 
1,317,964

 
14,723

 

 

 

 

 

 
14,723

Share-based compensation
 
61,184

 
61

 

 

 
1,061

 

 

 
1,122

Foreign currency translation gain (loss)
 

 

 

 

 

 

 
(8
)
 
(8
)
Net loss
 

 

 

 

 

 
(4,999
)
 

 
(4,999
)
Balances at March 31, 2017
 
8,497,901

 
21,902

 
(813,140
)
 
(3,611
)
 
4,099

 
(37,979
)
 
(8
)
 
(15,597
)
Issuance of ordinary shares
 
317,696

 
3,591

 

 

 

 

 

 
3,591

Cumulative change in accounting principle (adoption of ASU 2017-11)

 

 

 

 

 
958

 

 

 
958

Share-based compensation
 
37,254

 
37

 

 

 
663

 

 

 
700

Foreign currency translation gain (loss)
 

 

 

 

 

 

 
20

 
20

Net loss
 

 

 

 

 

 
(12,091
)
 

 
(12,091
)
Balances at June 30, 2017
 
8,852,851

 
25,530

 
(813,140
)
 
(3,611
)
 
5,720

 
(50,070
)
 
12

 
(22,419
)
Issuance of ordinary shares
 
394,795

 
5,527

 

 

 

 

 

 
5,527

Extinguishment of warrants with related party

 
207,716

 
208

 

 

 
2,192

 

 

 
2,400

Share-based compensation
 
42,026

 
42

 

 

 
526

 

 

 
568

Repurchase of shares
 

 

 
(408,070
)
 
(2,854
)
 

 

 

 
(2,854
)
Conversion of related party convertible notes payable

 
5,869,417

 
5,869

 

 

 
18,383

 

 

 
24,252

Foreign currency translation gain (loss)
 

 

 

 

 

 

 
(49
)
 
(49
)
Net loss
 

 

 

 

 

 
(10,674
)
 

 
(10,674
)
Balances at September 30, 2017
 
15,366,805

 
$
37,176

 
(1,221,210
)
 
$
(6,465
)
 
$
26,821

 
$
(60,744
)
 
$
(37
)
 
$
(3,249
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 


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

6

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

 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net loss
 
$
(10,584
)
 
$
(27,764
)
Adjustments to reconcile net loss to net cash used in operating activities:
 
 
 
 
Depreciation and amortization
 
2,041

 
1,351

Provision for doubtful accounts
 
25

 
650

Share-based compensation
 
4,966

 
2,390

Loss from disposal of property and equipment
 
76

 

Write off of deferred offering costs
 

 
1,585

Unrealized foreign currency (gain) loss, net
 
2,102

 

Change in fair value of derivative instruments
 
(15,945
)
 
2,104

Change in fair value of contingent consideration
 
1,446

 

Non-cash interest expense and amortization of debt discount
 
2,482

 
6,367

Changes in operating assets and liabilities:
 
 
 
 
Accounts receivable
 
(5,867
)
 
(784
)
Inventory
 
(3,346
)
 
(3,486
)
Prepaid expenses and other current assets
 
(3,811
)
 
(3,133
)
Other assets
 
(13
)
 
(546
)
Accounts payable
 
(2,460
)
 
(6,107
)
Accrued liabilities
 
3,674

 
2,582

Other liabilities
 
(191
)
 
963

Net cash used in operating activities
 
(25,405
)
 
(23,828
)
Cash flows from investing activities:
 
 
 
 
Purchases of property and equipment
 
(1,259
)
 
(1,388
)
Cost incurred for intangible assets
 
(41
)
 

Increase in restricted cash
 

 
96

Net cash used in investing activities
 
(1,300
)
 
(1,292
)
Cash flows from financing activities:
 
 
 
 
Borrowings on short-term notes payable
 

 
1,000

Borrowings under Madryn credit agreement, net of issuance costs
 

 
28,650

Repayments on short term notes payable
 

 
(1,200
)
Repayments on related-party notes payable
 
(5,083
)
 

Repayments under Perceptive credit agreement
 

 
(15,000
)
Payments of deferred offering costs
 

 
(914
)
Repayments on capital leases
 
(226
)
 
(138
)
Proceeds from issuance of ordinary shares, net of issuance costs
 
16,104

 
23,841

Proceeds from issuance of common shares, net of underwriters’ discount
 
71,523

 

Deferred equity issuance costs, IPO
 
(1,468
)
 

Cash used to repurchase warrants
 

 
(2,400
)
Proceeds from stock option exercises
 
616

 

Proceeds from warrant exercises
 
121

 

Shares repurchased
 

 
(4,507
)
Net cash provided by financing activities
 
81,587

 
29,332

Effect of exchange rate changes on cash
 
(169
)
 
(20
)
Net increase in cash
 
54,713

 
4,192

Cash at beginning of period
 
10,864

 
479

Cash at end of period
 
$
65,577

 
$
4,671

 
 
 
 
 
Supplemental disclosures:
 
 
 
 
Cash paid for interest
 
$
3,975

 
$
1,567

Cash paid for income taxes
 
$
89

 
$
70


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

7

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

 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
 
 
 
 
Supplemental disclosures of non-cash investing and financing activities:
 
 
 
 
Unpaid balance for property and equipment
 
$
645

 
$
754

Assets acquired under capital leases
 
$
50

 
$
52

Extinguishment of warrants with related party
 
$

 
$
958

Conversion of related party convertible notes payable into ordinary shares
 
$

 
$
24,252

 

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

8

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 and reconstructive plastic surgery. 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),Switzerland (JEN-Vault AG), the United Kingdom (Motiva Implants UK Limited) and Italy (Motiva Italy S.R.L). 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 at 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 and establishing wholly-owned subsidiaries. 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. During 2018, the Company has established wholly-owned subsidiaries in the United Kingdom and Italy.
Initial Public Offering
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 $70.1 million, after deducting underwriting discounts and commissions of $5.4 million and deferred offering costs of $1.5 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 Memorandum of Association and Articles of Association, or the 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 determined no further awards would be issued from the 2015 Equity Plan and approved the 2018 Equity Incentive Plan, or the 2018 Plan, with an initial reserve of 1,500,000 of the Company’s common shares for issuance;
The Board of Directors adopted the 2018 Employee Share Purchase Plan, or the ESPP, with an initial reserve of 100,000of the Company’s common shares for issuance.

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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 nine months ended September 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 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 September 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
Motiva Implants UK Limited
July 31, 2018
Motiva Italy S.R.L
July 31, 2018
 
 
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 September 30, 2018 and for the three and nine months ended September 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 September 30, 2018, and the results of its operations and cash flows for the nine months ended September 30, 2018 and 2017. Such adjustments are of a normal and recurring nature. The results for the three and nine months ended September 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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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 nine months ended September 30, 2018, Brazil accounted for 15.8% of consolidated revenue and no other individual country exceeded 10% of consolidated revenue, on a ship-to destination basis. For the nine months ended September 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 September 30, 2018 and December 31, 2017.
Use of Estimates
The preparation of financial statements in accordance with 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 nine months ended September 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 September 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 nine months ended September 30, 2018 and 2017, the Company had purchases of $10.6 million, or 64.9% of total purchases, and $7.8 million, or 39.0% of total purchases, respectively, from Nusil. As of September 30, 2018 and December 31, 2017, we had an outstanding balance owed to this vendor of zero 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

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Notes to Condensed Consolidated Financial Statements
(Unaudited)

individuals and sole source suppliers.
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 September 30, 2018 and December 31, 2017.
Restricted Cash
As of September 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. As of September 30, 2018, an allowance of $72,000 was recorded for product returns. Prior to 2018, returns of products have been de minimis and accordingly no allowance for returns was recorded as of 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 September 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 nine months ended September 30, 2018 and 2017, shipping and handling costs were $1.4 million and $0.9 million, respectively. For the three months ended September 30, 2018 and 2017, shipping and handling costs were $0.6 million and $0.5 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

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Notes to Condensed Consolidated Financial Statements
(Unaudited)

product, which represents the point in time when the customer has taken ownership and assumed the risk of loss 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. As of September 30, 2018, an allowance of $72,000 was recorded for product returns. Prior to 2018, returns of products have been de minimis and accordingly no allowance for returns was recorded as of December 31, 2017.
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

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

useful lives of five to ten years. Leasehold improvements are amortized on a straight-line basis over the shorter of 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 September 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 September 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

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

instruments in accordance with ASC 470-20 Debt with Conversion and Other Options. The Company records, 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, 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 condensed 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 nine months ended September 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)” as equity in the condensed consolidated balance sheet. 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” in the condensed consolidated statement of operations. For the nine months ended September 30, 2018, foreign currency transaction loss amounted to $3.2 million as compared to a foreign currency transaction gain of $24,000 for the nine months ended September 30, 2017.

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Notes to Condensed Consolidated Financial Statements
(Unaudited)

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. 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 $1.5 million of deferred offering costs which, upon completion of the IPO, were reclassified to equity to offset the IPO proceeds.
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, restricted stock units, or RSUs, 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 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 share is calculated by dividing the net income (loss) attributable to shareholders by the weighted-average number of 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) by the weighted-average number of shares and potentially dilutive securities outstanding for the period. For purposes of the diluted net loss per share calculation, any shares issuable upon exercise of share warrants, share options and non-vested restricted stock outstanding under the Company’s equity plan are potentially dilutive securities. Diluted net loss per share is the same as basic net loss per share for periods where the Company reported a net loss 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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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 January 2017, the FASB issued ASU No. 2017-01, Business Combinations (Topic 805): Clarifying the Definition of a Business, which provides additional guidance on evaluating whether transactions should be accounted for as acquisitions of assets or businesses. The guidance requires an entity to evaluate if substantially all of the fair value of the assets acquired is concentrated in a single identifiable asset or a group of similar identifiable assets. If this threshold is met, the new guidance would define this as an asset acquisition; otherwise, the entity then evaluates whether the asset meets the requirement that a business include, at a minimum, an input and substantive process that together significantly contribute to the ability to create outputs. The Company early adopted this ASU on a prospective basis on July 1, 2018. The adoption of this ASU did not have a material impact on the financial statements.
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.
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 August 2018, the FASB issued ASU 2018-13, Fair Value Measurement: Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements for fair value measurements. The modifications removed the following disclosure requirements: (i) the amount of, and reasons for, transfers between Level 1 and Level 2 of the fair value hierarchy; (ii) the policy for timing of transfers between levels; and (iii) the valuation processes for Level 3 fair value measurements. This ASU added the following disclosure requirements: (i) the changes in unrealized gains and losses for the period included in other comprehensive income ("OCI") for recurring Level 3 fair value measurements held at the end of the reporting period; and (ii) the range and weighted average of significant observable inputs used to develop Level 3 fair value measurements. This update is effective for non-public entities for annual and interim periods beginning after December 15, 2020, with early adoption permitted. As the requirements of this literature are disclosure only, ASU 2018-13 will not impact our financial condition or results of operations.
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

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Notes to Condensed Consolidated Financial Statements
(Unaudited)

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. The Company plans to complete the assessment on the impact of the ASU 2014-09 adoption in December 2018 and adopt the new standard on January 1, 2019.
3.     Balance Sheet Accounts
Inventory
 
 
 
 
 
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
(in thousands)
Raw materials
 
$
3,333

 
$
1,978

Work in process
 
60

 
1,132

Finished goods
 
11,972

 
10,063

 
 
$
15,365

 
$
13,173

 
 
 
 
 

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

Property and Equipment, Net
 
 
 
 
 
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
(in thousands)
Machinery and equipment
 
$
6,907

 
$
5,473

Vehicles
 
399

 
353

Furniture and fixtures
 
2,182

 
2,110

Leasehold improvements
 
8,041

 
8,743

Total
 
17,529

 
16,679

Less: Accumulated depreciation and amortization
 
(4,637
)
 
(3,179
)
 
 
$
12,892

 
$
13,500

 
 
 
 
 
For the nine months ended September 30, 2018 and 2017, depreciation and amortization expense related to property and equipment was $1.6 million and $1.1 million, respectively. For the three months ended September 30, 2018 and 2017, depreciation and amortization expense related to property and equipment was $0.5 million and $0.4 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 September 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.
The Company’s goodwill and most intangibles at September 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. 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.

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

There were no changes in the carrying amount of goodwill during the nine months ended September 30, 2018:
 
 
 
 
 
 
 
 
 
Balance as of January 1, 2018
 
Additions
 
Accumulated Impairment Losses
 
Balance as of September 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 September 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

 
$
(511
)
 
$
1,158

 
7-12
Customer relationships
1,304

 
(282
)
 
1,022

 
10
510(k) authorization
567

 
(109
)
 
458

 
15
Developed technology
62

 
(33
)
 
29

 
10
Capitalized software development costs
98

 
(86
)
 
12

 
2
Other
17

 
(17
)
 

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

 

 
291

 
 
 
$
4,008

 
$
(1,038
)
 
$
2,970

 
 
 
 
 
 
 
 
 
 

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

 
 
 
 
 
 
 
 
 
 


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

The amortization expense associated with intangible assets was $0.5 million and $0.2 million for the nine months ended September 30, 2018 and 2017, respectively. For the three months ended September 30, 2018 and 2017, amortization expense related to intangible assets was $0.2 million and $0.1 million, 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 September 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)
 
$
177

2019
 
551

2020
 
551

2021
 
511

2022
 
215

Thereafter
 
674

Total
 
$
2,679

 
 
 
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 September 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.
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.

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

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 September 30, 2018
 
Total
 
Level 1
 
Level 2
 
Level 3
 
 
 
 
 
 
 
 
 
(in thousands)
Liabilities
 
 
 
 
 
 
 
Madryn put option liability
$
4,717

 
$

 
$

 
$
4,717

Madryn call option liability

 

 

 

Acquisition-related contingent consideration
2,410

 

 

 
2,410

 
$
7,127

 
$

 
$

 
$
7,127

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
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 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 Lattice 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 September 30, 2018 and 90% at December 31, 2017.

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

The Company used the following assumptions to value Madryn derivatives:
Put Option Liability (Madryn)
 
 
 
 
 
September 30, 2018
 
December 31,
2017
Interest rate volatility
17.6%
 
21.0%
Market yield rate
13.0%
 
12.5%
Term (in years)
4.75
 
5.5
Dividend yield
—%
 
—%
 
 
 
 
Call Option Liability (Madryn)
 
 
 
 
 
September 30, 2018
 
December 31,
2017
Interest rate volatility
17.6%
 
21.0%
Market yield rate
13.0%
 
12.5%
Term (in years)
4.75
 
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) on the date of the agreement. As of September 30, 2018, the fair value of the contingently issuable shares was determined using the closing price of the Company’s publicly traded shares.
As of September 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 nine months ended September 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.

23

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

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

 
$

 
$

 
$

Issuance of financial instruments

 

 

 

Change in fair value
4,035

 

 

 

Repurchase of warrants
(7,060
)
 

 

 

De-recognition during period
(958
)
 

 

 

Balance at September 30, 2017
$

 
$

 
$

 
$

 
 
 
 
 
 
 
 
Balance at December 31, 2017
$

 
$
964

 
$
20,302

 
$
360

Change in fair value

 
1,446

 
(15,585
)
 
(360
)
Balance at September 30, 2018
$

 
$
2,410

 
$
4,717

 
$

 
 
 
 
 
 
 
 
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 nine months ended September 30, 2018 and 2017, the Company recorded interest expense of $0.2 million, to accrue for interest due on the notes. The Company repaid the balance due of $5.1 million, including accrued interest of $0.9 million, in August 2018.
The Company recorded the notes on the balance sheet as follows:
 
 
 
 
 
 
 
September 30,
2018
 
December 31,
2017
 
 
 
 
 
 
 
(in thousands)
Principal
 
$

 
$
4,218

Accrued interest
 

 
703

Total principal and accrued interest at end of period
 
$

 
$
4,921

 
 
 
 
 
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

24

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

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 September 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 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 September 30, 2018. The Company incurred $4.0 million in interest expense in connection with Madryn Credit Agreement during the nine months ended September 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

25

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

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 September 30, 2018.
The Company recorded Madryn debt on the balance sheet as follows:
 
 
 
 
 
September 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
(18,514
)
 
(20,833
)
Net carrying value of Madryn debt
$
21,486

 
$
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. 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 September 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.

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

For the nine months ended September 30, 2018 and 2017, rent expense was $0.7 million and $0.6 million, respectively. For the three months ended September 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.
Future minimum lease payments under the operating leases as of September 30, 2018 were as follows:
 
 
 
Years Ending December 31,
 
Operating
Leases
 
 
(in thousands)
2018 (remaining)
 
$
249

2019
 
938

2020
 
884

2021
 
823

2022
 
851

Thereafter
 
4,038

 
 
$
7,783

 
 
 
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 September 30, 2018 were as follows:
 
 
 
Years Ending December 31,
 
Capital
Leases
 
 
(in thousands)