Apollo Endosurgery
Annual Report 2019

Plain-text annual report

SECURITIES & EXCHANGE COMMISSION EDGAR FILING Apollo Endosurgery, Inc. Form: 10-K Date Filed: 2020-03-26 Corporate Issuer CIK: 1251769 © Copyright 2020, Issuer Direct Corporation. All Right Reserved. Distribution of this document is strictly prohibited, subject to the terms of use. version="1.0" ?> UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FORM 10-K TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the fiscal year ended December 31, 2019 OR ☒ ☐ For the transition period from to Commission file number: 001-35706 APOLLO ENDOSURGERY, INC. (Exact name of registrant as specified in its charter) Delaware (State or other jurisdiction of incorporation or organization) 1120 S. Capital of Texas Highway , Building 1, Suite #300 , Austin, Texas (Address of principal executive offices) 16-1630142 (I.R.S. Employer Identification No.) 78746 (Zip Code) Registrant’s telephone number (512) 279-5100 Securities registered pursuant to Section 12(b) of the Act: Title of each class Common Stock, $0.001 par value per share Trading Symbol(s) APEN Name of Exchange on which registered The Nasdaq Global Market Securities registered pursuant to Section 12(g) of the Act: None Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act Yes ☐ No ☒ Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Exchange Act. Yes ☐ No ☒ Indicate by check mark whether the registrant (1) filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 ☐ 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 ☐ Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a 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. (Check one): Large accelerated filer ☐ Non-accelerated filer ☒ Accelerated filer ☐ Smaller reporting company ☒ Emerging growth company ☐ 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 Exchange Act). Yes ☐ No ☒ The aggregate market value of the common stock held by non-affiliates of the registrant (assuming for these purposes, but without conceding, that all executive officers and directors of the registrant are affiliates of the registrant) was computed based on the adjusted close price of $3.25 as reported on the Nasdaq Global Market on June 28, 2019 is $48,935,591. As of February 28, 2020, there were 21,116,760 shares of the issuer’s $0.001 par value common stock issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Portions of the Definitive Proxy Statement for the registrant’s 2020 Annual Meeting of Stockholders are incorporated by reference into Part III of this Annual Report on Form 10-K. The Definitive Proxy Statement will be filed no later than 120 days after the close of the registrant’s fiscal year ended December 31, 2019. EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. APOLLO ENDOSURGERY, INC. AND SUBSIDIARIES TABLE OF CONTENTS Item 1. Item 1A. Item 1B. Item 2. Item 3. Item 4. Item 5. Item 6. Item 7. Item 7A. Item 8. Item 9. Item 9A. Item 9B. Item 10. Item 11. Item 12. Item 13. Item 14. Item 15. Item 16. PART I Business Risk Factors Unresolved Staff Comments Properties Legal Proceedings Mine Safety Disclosure PART II Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities Selected Financial Data Management’s Discussion and Analysis of Financial Condition and Results of Operations Quantitative and Qualitative Disclosures about Market Risk Financial Statements Changes in and Disagreements with Accountants on Accounting and Financial Disclosure Controls and Procedures Other Information PART III Directors, Executive Officers and Corporate Governance Executive Compensation Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters Certain Relationships and Related Transactions, and Director Independence Principal Accountant Fees and Services PART IV Exhibits and Financial Statement Schedules Form 10-K Summary Signatures Index to Consolidated Financial Statements Page 2 2 15 38 38 38 38 39 39 39 39 50 51 72 72 73 73 73 73 74 74 74 75 75 78 79 i EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. FORWARD-LOOKING STATEMENTS This Annual Report on Form 10-K contains forward-looking statements. The forward-looking statements are contained principally in the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business.” These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terms such as “anticipates,” “believes,” “could,” “estimates,” “expects,” “intends,” “may,” “plans,” “potential,” “predicts,” “projects,” “should,” “will,” “would,” and similar expressions intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events, are based on assumptions (disclosed or undisclosed) and may be limited or incomplete, and are subject to risks, uncertainties and other important factors. We discuss many of these risks in this Annual Report on Form 10-K in greater detail in the section entitled “Risk Factors” under Part I, Item 1A below. Given these risks, uncertainties and other important factors, you should not place undue reliance on these forward-looking statements as predictions of future events. Also, forward-looking statements represent our estimates and assumptions only as of the date of this Annual Report on Form 10-K. You should read this Annual Report on Form 10-K and the documents that we incorporate by reference in and have filed as exhibits to this Annual Report on Form 10-K, completely and with the understanding that our actual future results may be materially different from what we expect. In addition, statements that "we believe" and similar statements reflect our beliefs and opinions on the relevant subject. These statements are based upon information available to us as of the date of this Annual Report on Form 10-K, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements are inherently uncertain and investors are cautioned not to unduly rely upon these statements. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future. As used herein, “Apollo,” “we,” “us,” “our” and “Company” refer to Apollo Endosurgery, Inc. and its subsidiaries, unless the context otherwise requires. In this Annual Report on Form 10-K, references to U.S. dollars, USD or $ are to U.S. Dollars. Investors and others should note that we announce material financial information to our investor using our investor relations website (https://ir.apolloendo.com/). SEC filings, public conference calls and webcasts. We use these channels to communicate with our members and the public about our company, our services, and other issues. Therefore, we encourage investors, the media, and others interested in our company to review the information we provide on the channels listed above. 1 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. ITEM 1. BUSINESS Overview PART I We are a medical technology company primarily focused on the design, development and commercialization of innovative medical devices to advance gastrointestinal therapeutic endoscopy. Our strategic focus and our future revenue growth is expected to come from our Endoscopy product portfolio, which consists of the OverStitch TM Endoscopic Suturing System and Orbera® managed weight loss system. We are one of the market share leaders in less invasive devices that treat various gastrointestinal ("GI") conditions, ranging from advanced GI procedures to the treatment of obesity. Our products are used by gastroenterologists and bariatric surgeons in a variety of settings to treat multiple GI conditions including closure of acute perforations and chronic fistulas; inadvertent perforation of the GI tract; tissue closure after the removal of abnormal lesions in the esophagus, stomach or colon (also known as endoscopic submucosal dissections and endoscopic mucosal resections); the treatment of swallowing disorders (peroral endoscopic myotomy, or "POEM"); esophageal stent fixation and obesity. In the past, a portion of our product revenues has come from the Surgical product line, which consisted of the Lap-Band ® System and related laparoscopic accessories. This product line was sold in December of 2018; however, we continued to provide distribution services in certain markets to the buyer during 2019 and reported revenue from this activity. These distribution services ceased in the fourth quarter of 2019. Surgical product sales represented 7% and 31% of our consolidated revenues in 2019 and 2018, respectively. Corporate Background Apollo was founded in 2005 and is incorporated in Delaware with headquarters in Austin, Texas. The Company was founded to develop and commercialize innovations originating from a collaboration of physicians from the Mayo Clinic, Johns Hopkins University, Medical University of South Carolina, the University of Texas Medical Branch and the Chinese University of Hong Kong, who called themselves the Apollo Group. The work of the Apollo Group resulted in a significant portfolio of patents in the field of flexible endoscopy and minimally invasive surgery aimed at minimizing the trauma of surgical access by taking advantage of natural orifices to deliver surgical tools to targeted areas. In December 2013, we entered into an asset purchase agreement to acquire the obesity intervention division of Allergan, Inc. The assets acquired were the Lap-Band System and related laparoscopic surgery accessories and the Orbera Intragastric Balloon System. In conjunction with this purchase agreement, we entered into several agreements whereby Allergan agreed to provide manufacturing and distribution support over a two-year period as we established alternative manufacturing and worldwide distribution capabilities. Following this acquisition, we established offices in the United Kingdom, Australia, Italy and Brazil that oversee regional sales and distribution activities outside the U.S. and a manufacturing facility in Costa Rica. All other activities are managed and operated from our facilities in Austin, Texas. In December 2016, we completed a business combination (the "Merger") with Lpath, Inc. ("Lpath"), a publicly traded company. Following the Merger, Lpath was renamed "Apollo Endosurgery, Inc." and our common stock began trading on The Nasdaq Global Market under the symbol "APEN." In December 2018, Apollo entered into an Asset Purchase Agreement ("Purchase Agreement") with ReShape Lifesciences, Inc. ("ReShape") pursuant to which, among other things, ReShape acquired from Apollo substantially all of our assets exclusively related to the Surgical product line for $10.0 million in cash and future cash consideration of $7.0 million. As additional consideration, we also received from ReShape substantially all of their assets exclusively related to their intragastric balloon product line. On December 31, 2018, we ceased sales of ReShape's intragastric balloon product and have since withdrawn its premarket approval ("PMA"). "Orbera", "OverStitch", the Apollo logo and other trademarks or service marks of Apollo Endosurgery, Inc. appearing in this annual report are the property of Apollo Endosurgery, Inc. Other trademarks, service marks or trade names appearing in this annual report are the property of their respective owners. We do not intend our use or display of other companies' trade names, trademarks or service marks to imply a relationship with, or endorsement or sponsorship of us, by these other companies. 2 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Our principal executive offices are located at 1120 S. Capital of Texas Highway, Building 1, Suite 300, Austin, Texas 78746. Our telephone number is (512) 279-5100. We have a Code of Business Conduct and Ethics that applies to all of our directors, officers and employees. A copy of this document is published on the Apollo website at www.apolloendo.com/compliance and may be obtained free of charge by writing to the Director of Compliance at our principal executive office or by email at investor-relations@apolloendo.com. The information in or accessible through the Apollo website referred to above are not incorporated into, and are not considered part of, this report. Overview of the Market The majority of procedures performed using our Endoscopy products are either related to gastrointestinal complication management or obesity intervention. Interventional and therapeutic gastroenterology is a high growth area within medicine and our suturing products are used in both the upper and lower GI tract. Examples of upper GI applications include fistula closure, esophageal stent fixation, and closure for POEM. Fistulas are chronic or acute defects that can form between two cavities in the GI tract, often occurring as a result of abdominal surgery. Esophageal stents are often used as part of the treatment of esophageal cancers and fixation is designed to prevent the premature migration of the stent, which is common and costly. Clinical evidence shows that esophageal stents that are not fixed in place will have as high as a 60% migration rate. Suturing stents in place helps reduce stent migration, saving an average of $860 per patient by preventing repeat procedures and complications for the patient. Achalasia is a condition where a patient has difficulty swallowing. As the incidence of achalasia increases, there is growing interest in endoscopic treatment options that can be offered, such as the POEM procedure. Suturing following the esophageal muscle dissection and release during a POEM presents a quick and low profile solution for the patient. In the lower GI tract, there are over 20 million colonoscopies performed annually. Cancer screening followed by the endoscopic resection of flat gastrointestinal tumors or polyps can provide patients with a viable option to colorectal surgery. Delayed bleeding is a general risk of endoscopic resection and older patients who are often on anti-thrombotic (blood thinning) medications carry a higher risk of bleeding. Suturing the resection site aids in healing and helps prevent delayed bleeding following the procedure. Obesity as a disease is increasing worldwide. In the U.S., it is estimated that 78 million adults are obese or clinically obese with a body mass index ("BMI") of 30 or more. Worldwide, over 650 million people are considered obese. Traditional obesity intervention has been bariatric surgery (gastric bypass, sleeve gastrectomy and laparoscopic adjustable gastric banding), which is mostly performed laparoscopically. Today, based on U.S. population demographics and physician society reported bariatric procedure volumes, less than 2% of the population eligible for bariatric surgery elect to have a procedure. We believe that the patient's primary detraction from bariatric surgery is fear of surgery in general, but more specifically fear associated with the invasive nature of bariatric surgery, permanent anatomical alteration, potential for non-permanent results and the post-operative severe complications that have been reported with bariatric surgery. Apollo's Strategy Our objective is to provide products that advance endoscopic solutions for a wide range of interventional patient needs ranging from gastrointestinal complication management to the treatment of obesity. Our "Endoscopy" products allow these solutions to be delivered endolumenally by an endoscopist using a flexible endoscope, thus providing patients with treatment options that remove or defer the need for traditional surgery. The key elements of our strategy include: • • Support the adoption of our Endoscopy products - We accomplish this today through our medical education activities, field sales support, and clinical investments that support product adoption and use. In addition, we invest in clinical studies, such as the Multi-center ESG Randomized Intervention Trial ("MERIT") study, to support both future payor reimbursement decision-making for procedures that utilize our products and potential new indications for our products. Continue to deliver innovative products and broaden the product portfolio - Prior to 2019, our suturing technology could only be used with a specific dual-channel flexible endoscope, which represented less than five percent of the flexible endoscopes in use at hospitals and clinics around the world. In late 2018, we introduced the OverStitch Sx Endoscopic Suturing System which enabled our suturing technology to be used with multiple manufacturers' single-channel flexible endoscopes, representing the majority of flexible endoscopes in use today. We are currently internally developing a colonoscope-compatible suturing device in order to make our technology more readily accessible during lower GI tract procedures and anticipate filing a 510k application for such a device during 2020. We intend to continue to broaden our portfolio of products 3 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. through internal product development efforts and will consider acquisitions that complement our current business. • Expand into new markets -We intend to continue to pursue regulatory clearance for our products in key international markets where we believe there is potentially strong market demand for our products. Apollo Products Endoscopy The Apollo Endoscopy products consist primarily of the OverStitch Endoscopic Suturing System and the Intragastric Balloon System (most often branded as Orbera). For the year ended December 31, 2019, 89% of total revenues were from sales of the Endoscopy products. Of our total Endoscopy sales, 63% related to the OverStitch Endoscopic Suturing System and 37% related to the Orbera Intragastric Balloon System products. OverStitch Endoscopic Suturing System The OverStitch and OverStitch Sx Endoscopic Suturing System ("ESS", "OverStitch", or "Sx") enables advanced endoscopic procedures from within the GI tract, or endolumenally, by allowing physicians to place full-thickness sutures and secure the approximation of tissue. OverStitch and OverStitch Sx are currently the only U.S. cleared flexible endoscopic suturing devices capable of full-thickness suturing of tissue. OverStitch is a single-use suturing device that is attached to a flexible endoscope. The flexible endoscope, with the OverStitch device attached, allows a physician to access portions of a patient's GI tract and then place full thickness sutures to approximate the tissue inside the GI tract for many different clinical needs, including defect repairs, esophageal stent fixation to prevent stent migration, and volumetric space reduction. The OverStitch Endoscopic Suturing System received U.S. Food and Drug Administration ("FDA") 510(k) clearance in August 2008 and CE Mark in November 2012. The OverStitch Sx Endoscopic Suturing System received FDA 510(k) clearance in June 2018 and CE Mark in November 2018. The OverStitch device that was 510(k) cleared in August of 2008 is compatible with a specific dual channel flexible endoscope that has limited market presence, representing less than five percent of the flexible endoscopes in hospitals and clinics around the world. Beginning in November 2018, we began the first commercial shipments of the OverStitch Sx that is compatible with four major scope manufacturers and over 20 single-channel flexible endoscopes with diameters ranging from 8.8 mm to 9.8 mm. These Sx compatible single-channel endoscopes represents the majority of flexible endoscopes in hospitals and clinics around the world today. Since its market introduction in 2008, over 45,000 OverStitch units have been sold for procedures worldwide. We estimate that approximately 40% of procedures performed with OverStitch were in connection with the treatment of GI complications and the remaining use was for the treatment of obesity. One of the most promising newly developed weight-loss procedures is commonly referred to as endoscopic sleeve gastroplasty ("ESG"), which transorally uses endoscopic suturing with OverStitch to reduce the volume of the stomach and form a small diameter sleeve, similar to the goal of a surgical sleeve gastrectomy procedure but without the invasiveness and need for amputation of the gastric remnant. The advantages of the ESG as compared to a surgical sleeve gastrectomy include keeping the original structural and functional integrity of the stomach, reversibility, relative ease of revision or maintenance, lower procedure adverse events, and reduced costs. ESG is based on the placement of full-thickness sutures to secure the approximation of tissue which is the labeled indication of OverStitch. However, the labeled indication of the OverStitch device currently does not specifically identify the ESG procedure. The first multi-center study was presented in May 2016 at Digestive Disease Week which was later updated as a 24-month follow-up study that was published in April 2017 in Obesity Surgery, the Journal of Metabolic Surgery and Allied Care. This was a three center (two in the U.S. and one in Spain) investigator-initiated study of medical records of patients who underwent ESG from January 2013 to November 2015. All procedures were performed in a similar fashion using the OverStitch device to endolumenally place full-thickness sutures to fold in the greater curvature of the stomach, and reduce the volumetric capacity of the stomach in order to lower a patient's caloric intake and induce weight loss. A total of 248 patients were included in the study. Patient BMI at the start of the study was 37.8, plus or minus 5.6. • • • 215 patients reached 6-months follow-up and the study reported an average percentage total body weight loss ("TBWL") of 15.2%. 57 patients reached 24-months follow-up and the study reported an average TBWL of 18.6%. There was no significant difference in weight loss between the three centers. 4 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Five serious adverse events occurred: two perigastric inflammatory fluid collections that resolved with percutaneous drainage and antibiotics, one self-limited hemorrhage from splenic laceration, one pulmonary embolism 72 hours after the procedure, and one pneumoperitoneum and pneumothorax requiring chest tube placement. All five patients recovered fully. The suturing-related serious adverse events were associated by the study's authors with suturing to reduce the fundus part of the stomach and as a result, reducing the fundus is no longer part of the standard ESG technique. Subsequently, there have been numerous published investigator-initiated ESG studies conducted by a variety of physicians around the world. In 2019, four separate meta-analyses were published that pooled the results from eight published ESG studies involving more than 1,700 patients. These four meta-analyses demonstrated between 15% to 20% total body weight loss measured at periods between 6 to 24 months and low adverse event rates. In 2017, we entered into a clinical trial agreement with The Mayo Clinic in Rochester, Minnesota to undertake the MERIT trial to evaluate the long-term safety and efficacy of ESG compared to efficacy endpoints set forth in a consensus statement of the American Society for Gastrointestinal Endoscopy ("ASGE") and the American Society of Metabolic Bariatric Surgery ("ASMBS") and its impact on obesity related comorbidities in patients with obesity and BMI between 30-45. The MERIT-Trial was designed to enroll two hundred patients, stratified into three groups (Obesity, Obesity with hypertension, Obesity with diabetes). The trial will have two levels: (1) the randomized study phase with primary outcomes for both treatment and control participants evaluated at twelve months, and (2) the crossover, non-randomized study phase with outcomes for (a) the initial treatment participants at 24 months after their ESG, and (b) the control cross-over participants evaluated at twelve months after their ESG. During 2019, the MERIT trial received an Investigational Device Exemption from the FDA and enrollment was completed. During 2017, we entered into a Registry Funding Agreement with the American Gastroenterological Association ("AGA") Center for GI Innovation and Technology to develop and administer a registry (the “AGA Registry”) to collect real-world evidence related to the safety and efficacy of a number of flexible endoscopic suturing-enabled procedures, including the revision of gastric bypass (known as an outlet revision) or sleeve gastrectomy patients who have experienced weight regain after their initial bariatric surgery; the fixation of esophageal stents to prevent migration; and other suturing procedures currently in practice. The resulting data will be used to present the benefits of endoscopic suturing procedures relative to traditional therapies. We expect the AGA to collect data for four years with the potential for interim reporting. During 2018, in Europe, we established a multi-center, longitudinal data repository for ESG and outlet revision procedures that will extend up to two years. This registry will collect outcomes across European centers related to safety and effectiveness of procedures performed. In addition, a second, multi-center, retrospective data repository for gastrointestinal applications performed using the OverStitch System was also created. The objective of this registry is to collect European demographic, procedural and outcome data when OverStitch is used for various non-weight loss procedures including closure of full thickness and mucosal defects, post-operative leaks, perforations, stent fixation, treatment of gastrointestinal bleeding and other procedures. The goal is to support the clinical use and benefits of endolumenal suturing as well as provide real-world data on safety and effectiveness which can support physicians, patients and payors in making informed decisions. This registry could extend up to five years. Both registries are expected to provide interim reporting. Additional applications for endoscopic suturing are emerging as physicians gain suturing proficiency and identify additional patient needs. In June 2018, Endoscopy International published for example a study of a novel resection and plication anti-reflux procedure ("RAP") using OverStitch. In this patient series, RAP was performed on 10 patients with gastroesophageal reflex disease ("GERD") and on long-term proton pump inhibitor ("PPI") therapy. All the patients underwent RAP without adverse events and were discharged on the same day. Follow-up ranged from 5 to 24 months, with the median being 9 months, and all patients were reported as having significant improvement in their GERD based quality of life scores, and 8 of the 10 patients had eliminated their daily PPI use. Orbera Intragastric Balloon System The intragastric balloon system ("IGB", the "Orbera System" or "Orbera") is currently marketed under three brands: the Orbera Intragastric Balloon System, the BIB, and the Orbera365 Managed Weight Loss System ("Orbera365") and are non-surgical alternatives for the treatment of overweight adults. Orbera is the global market leader among intragastric balloons and is available in over 75countries with more than 300,000 units sold for procedures worldwide. The IGB brands each include a single silicone balloon that is filled with saline after its endoscopic placement into the patient's stomach. Once in the patient's stomach, the balloon serves to reduce stomach capacity, causing patients to consume less following the procedure, and delay gastric content emptying which assists the patient in losing weight. Placement of the balloon is temporary and at the end of its indwell time is removed endoscopically, typically, under conscious sedation. Outside the U.S., the BIB was CE marked in May 1997 and the Orbera365 was CE marked in August 2017. In the U.S., Orbera was approved by the FDA in August 2015. 5 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. In the U.S., Orbera is indicated for an indwell period of up to six months for adults within a BMI range of 30 to 40 who have tried other weight loss programs, such as supervised diet and exercise, but who were unable to lose weight and keep it off. Outside the U.S., Orbera is generally indicated for temporary weight loss for patients with a BMI greater than or equal to 27, and depending on the specific label, is indicated for an indwell time of six or twelve months. In some cases, generally higher BMI patients, Orbera is indicated for use prior to surgery, including obesity surgery, in order to reduce surgical risk. Today, IGBs are most often used for aesthetic weight loss purposes and because of this, the IGB procedure is typically not covered by insurance and is paid for directly by the patient. Aesthetics is also the primary market today for Orbera; however, we believe that IGB use for medical purposes is a potentially larger opportunity. Specific to Orbera, there is a substantial and increasing body of evidence that shows that the level of weight loss with Orbera is very effective in the treatment of comorbidities associated with being overweight or obese. The clinical effectiveness and safety profile of the Orbera System as a non-ulcerogenic weight loss device has been reported in over 250 peer reviewed publications. Although not specifically indicated for the treatment of obesity-related comorbidities, studies have consistently reported resolution or improvement in a patient's pre-existing comorbidities at the time of Orbera removal. Orbera is currently the only balloon or other endoscopic product that has been recognized in the ASGE Preservation and Incorporation of Valuable Endoscopic Innovations assessment to have met its threshold standards for the treatment of obesity. The meta-analysis performed by the ASGE was based on the aggregation of certain clinical studies conducted outside the U.S. and reported an estimated TBWL at six months of approximately 13.2%. For example in June 2018 during Digestive Disease Week, physicians from Mayo Clinic presented on their prospective open-label FDA-approved study of Orbera patients with non-alcoholic steatohepatitis ("NASH"). Of the patients treated, 65% achieved resolution of NASH on biopsy; 80% had at least a two point improvement in their non-alcoholic fatty liver disease activity score; and 15% had tissue evidence indicating regression of fibrosis (liver scarring). NASH is expected to become the most common cause of liver cirrhosis by 2030, leading to increased risk of liver-related death and higher rates of malignancy. Our commercial strategy is to further establish the medical relevancy of Orbera in areas of large medical need such as fatty liver disease and increase clinician awareness of this relevancy. We provided research grants to support pilot studies to explore medical relevancy applications which are currently underway. As part of the FDA approval of Orbera, we are required to conduct a post-approval clinical study. The Orbera Post-Approval Study is a prospective, multi- center, open-label study of the safety and effectiveness of Orbera as an adjunct to weight reduction for obese adults (22 years of age and older) with a BMI of ≥ 30 kg/m2 and BMI ≤ 40 kg/m2. The Orbera Post Approval Study completed enrollment in September 2018 with 281 patients treated with Orbera from 11 U.S. clinical study sites. The endpoints include the patient's percentage of total body weight loss at 26 weeks and 12 months after balloon placement and the rate of adverse events at 26 weeks. Patient follow up was completed as expected in 2019, and a final study report was submitted to the FDA in early 2020 for their review. Pending FDA's review and acceptance of this submission, we believe that all endpoints of the study were met. As part of the CE mark approval for Orbera 365, we are required to conduct a post-approval clinical study. The Orbera 365 CE post approval study will enroll 100 patients at four to five centers in different European countries who will be followed for 24 months. In February 2017, the FDA issued a letter to health care providers related to adverse events following placement of liquid-filled balloons which were not seen during the U.S. pivotal studies, specifically related to events of spontaneous balloon over-inflation and, separately, reports of acute pancreatitis. We subsequently developed updates to Orbera's product labeling and physician training materials, and these were approved by FDA and implemented in June 2017. The labeling changes included additions to the “Warnings” and “Possible Complications” sections and an update to the “Clinical Evaluations…” sub-section within the “Adverse Events” history for Orbera. In August 2017, the FDA issued a second update to alert health care providers of five reports of unanticipated deaths that occurred since 2016 in patients with a liquid-filled intragastric balloon implant. Four of the deaths involved patients who had received an Orbera and had been self-reported by us to the FDA as part of our normal product surveillance process. Following this letter, we interactively worked with the FDA to provide further updates regarding the risks of gastric and esophageal perforation, aspiration, and death and updated the label disclosure for these adverse events as well as the physician training material to provide more detailed descriptions of the patient symptoms that may indicate persistent (or refractory) intolerance, methods of assessing these patients, and recommendations for the management of symptoms and removal of the device. In June 2018, the FDA approved new Orbera labeling and concurrent with their approval issued a third update to alert health care providers of the label updates and provide an update on new reports worldwide of unanticipated deaths that had been reported since their August 2017 letter to Health Care Providers. Four of the reported deaths in this third update involved patients who had received our IGB product. In each case, the occurrence had been self-reported by us to the FDA as part of our 6 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. normal product surveillance process. In the period from January 1, 2008 through January 31, 2019, there were 29 reported deaths of patients while they had an Orbera which is an incident rate of less than 0.01% based on the more than 300,000 Orbera balloons distributed during that same time period. In the U.S., we also offer Apollo Care, a professional nutritionist support service for Orbera patients and non-Orbera patients who are trying to lose weight. Surgical In December 2018, Apollo entered into an agreement with ReShape to divest its Surgical product line. As part of the agreement Apollo and ReShape entered into a set of transition services agreements under which Apollo continued to distribute the products in markets outside the U.S. for up to 12 months and will continue to manufacture the Surgical product line for up to two years. As of December 31, 2019, all transition and distribution services are complete and we remain obligated to manufacture product for ReShape until December 2020. Competition We are the only manufacturer with a cleared device for full thickness endoscopic suturing currently on the market in the U.S. or outside the U.S. Competing technologies for closure during certain GI applications are offered by large and established manufacturers in the GI space including Boston Scientific Corporation, Olympus Medical, Steris (US Endoscopy) and Cook Medical. Outside the U.S., there are a variety of local and regional competitive intragastric balloon manufacturers including SC MedSil, Medicone, Allurion Technologies and Spatz Laboratories. In the U.S., there is one other manufacturer with an intragastric balloon approved by the FDA at this time, Obalon Therapeutics, Inc. We face competition from other interventional therapies for the treatment of obesity that do not use our products as well as from other manufacturers with similar products to ours with the same intended mode of action. These other therapies are primarily surgical in nature, such as sleeve gastrectomy and gastric bypass. Sleeve gastrectomy is a surgical weight-loss procedure in which the stomach is reduced to about 15% of its original size by the longitudinal resection and removal of a large portion of the stomach along the greater curvature. The result is a sleeve or tube like structure. The procedure permanently alters the stomach although weight regain after a few years is common. The procedure is generally performed laparoscopically and is irreversible. Gastric bypass surgery refers to a surgical procedure in which the stomach is divided into a small upper pouch and a much larger lower remnant pouch and then the small intestine is rerouted to connect to the small upper pouch. The procedure leads to a marked reduction in the functional volume of the stomach, accompanied by an altered physiological and physical response to food. Both procedures are normally performed laparoscopically and rely upon surgical staplers as their principal surgical tool. As a result, these procedures are supported by the suppliers of surgical staplers, the largest of whom are Johnson & Johnson (Ethicon) and Medtronic (Covidien). Both companies have substantially more resources and ability to influence physicians and policy-makers than we do. Sales and Distribution We currently market and sell our products principally to providers of medical services and procedures including hospitals, outpatient surgical centers, clinics and physicians through an employee sales force in the U.S., Brazil, Australia and certain countries in Europe. As of December 31, 2019, we employed 52 sales and marketing personnel in the U.S. and another 37 employees in our direct markets outside of the U.S. In addition, we sell products to third party distributors in certain markets where we have regulatory clearance for our products but do not have employees. In total, our products are offered in over 75 countries. Obesity procedures that utilize our Endoscopy products are often cash pay procedures which means that the patient must pay for the procedures out of pocket, although there are exceptions. Revisions of prior bariatric surgery using endoscopic suturing are routinely receiving reimbursement from select payors for patients treated at specific hospitals in the U.S. Some of these same hospitals have also established relationships with select payors for the reimbursement of ESG procedures. Other times, reimbursement occurs on a case-by-case basis following a review of the patient's specific situation. Medical procedures that utilize endoscopic suturing products in the treatment of GI complications generally receive reimbursement, but coverage can vary by country, state and procedure performed. IGB treatment is reimbursed in certain European countries and, beginning in January of 2020, by private health insurance in Brazil for patients who meet certain criteria. 7 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Manufacturing and Product Supply We manage all aspects of product supply through our operations team based in Austin, Texas. We operate a light manufacturing facility in the Coyol Free Trade Zone in Alajuela, Costa Rica that performs final assembly for select components related to the OverStitch system and our IGB products. Our goal is to expand the number and volume of OverStitch system products and components produced in Costa Rica. In addition, we rely on several third-party suppliers to provide other OverStitch system components. We also manufacture the LapBand product as required to fulfill our manufacturing obligation to ReShape at the Costa Rica facility. We expect to improve gross margins as we complete certain identified gross margin improvement projects and improve capacity utilization of our manufacturing facility. We believe that our existing manufacturing facilities give us the necessary physical capacity to produce sufficient quantities of products to meet anticipated demand for at least the next twelve months. Our manufacturing facility is certified by the International Organization for Standardization, or ISO, and operates under the FDA's good manufacturing practice requirements for medical devices set forth in the Quality System Regulation, ("QSR"). Intellectual Property We have developed and acquired significant know-how and proprietary technology, upon which our business depends. To protect our know-how and proprietary technology, we rely on trade secret laws, patents, copyrights, trademarks and confidentiality agreements and contracts. However, these methods afford only limited protection. Others may independently develop substantially equivalent proprietary information or technology, gain access to our trade secrets or disclose or use such secrets or technology without our approval. We protect trade secrets and proprietary knowledge in part through confidentiality agreements with employees, consultants and other parties. We cannot assure you that our trade secrets will not become known to or be independently developed by our competitors. Apart from the portfolio of patents and applications to the Lpath technology, we own over 102 U.S. patents and 125 foreign patents. Our U.S. patents have expiration dates ranging from 2021 to 2037 and our foreign patents have expiration dates ranging from 2022 to 2034 subject to the payment of the requisite renewal fees. We also own 21 pending U.S. patent applications and 28 pending foreign patent applications. We believe patents will be issued pursuant to such applications but cannot guarantee it. Moreover, neither the timing of any issuance, the scope of protection, nor the actual issue date of these pending applications can be forecasted with precision. Where we have acquired or licensed patent rights from third parties, we are generally required to pay royalties. While our patents are an important element of our products and future product development, our business as a whole is not significantly dependent on any one patent. Our patents may not provide us with effective competitive advantages. Our pending or future patent applications may not be issued. Others may hold or obtain patents that cover aspects or uses of our innovations. The patents of others may render our patents obsolete, limit our ability to patent or practice our innovations, or otherwise have an adverse effect on the ability to conduct business. Because foreign patents may afford less protection than U.S. patents, they may not adequately protect our technology in markets outside the U.S. In 2009, we entered into an Intellectual Property Assignment Agreement, with Olympus Corporation and the "FTE Group" comprised of The Johns Hopkins University, Mayo Foundation for Medical Education and Research, The University of Texas Medical Branch, MUSC Foundation for Research Development and the Chinese University of Hong Kong, whereby the FTE Group has assigned to us a Joint Research Agreement with Olympus Corporation, including their rights in certain inventions, patents and IP rights developed by FTE Group under the Joint Research Agreement, which relate to the field of flexible endoscopy and minimally invasive surgery. Olympus Corporation has retained rights as a joint owner of certain inventions and related patents developed jointly by FTE Group and Olympus Corporation under the Joint Research Agreement and retained a license granted by FTE Group to Olympus Corporation to the inventions and related patents developed by FTE Group under the Joint Research Agreement. The patents covered by the agreement pertain to endoscopic procedures and endoscopic suturing devices that relate to the OverStitch products and may also be incorporated into potential new products that we may develop in the future. As consideration for the assignment, we are obligated to pay to each of Olympus and the FTE Group one half of a royalty in the low single digits on net sales of our products covered by the patents, which royalty shall be reduced if related patents have expired or no longer exist. In addition, we have the right to sublicense our rights under the Joint Research Agreement to the patents and technologies. The term of the Intellectual Property Assignment Agreement is through and until termination. The agreement may be terminated upon written notice a) by Olympus if we materially breach any material terms that pertain to Olympus and the breach is not cured within 30 days after notice, b) by the FTE Group if we materially breach any of the material terms that pertain to the FTE Group and the breach is not cured within 30 days after notice or c) by us if Olympus materially breaches any material terms that pertain to Olympus and the breach is not cured within 30 days after notice. 8 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Following the Merger, we also own 47 U.S. and foreign issued patents and 29 pending U.S. and foreign patent applications relating to technologies and inventions developed by Lpath prior to the Merger (the “Lpath IP”). The Lpath IP is not aligned with our current business activities. In January 2018, we entered into a royalty-bearing License Agreement with Echelon Biosciences, Inc., ("Echelon") under which Echelon may manufacture and sell certain antibody products covered by the Lpath IP for non-clinical research use only, clinical diagnostics and immunohistochemistry. In January 2018 we also entered into a Technology Transfer Agreement with Resolute Pharma, Inc. (“Resolute”) whereby we transferred certain scientific and research materials to Resolute and granted Resolute a license to certain patent rights related to the Lpath IP. Under the terms of the agreement with Resolute, Resolute has obligations to develop and commercialize licensed products and we maintain rights to terminate the agreement if certain development and commercialization milestones are not met. Under the agreement, Resolute is responsible to pay for any ongoing costs and fees associated with the Lpath IP, and we are entitled to a royalty for any revenues related to the Lpath IP including sales of licensed products, and a Tech Transfer Fee of $0.75 million. Government Regulation The healthcare industry, and thus our business, is subject to extensive federal, state, local and foreign regulation. Some of the pertinent laws have not been definitively interpreted by the regulatory authorities or the courts, and their provisions are open to a variety of interpretations. In addition, these laws and their interpretations are subject to change. Unless an exemption applies, each new or significantly modified medical device we seek to commercially distribute in the U.S. will require either a premarket notification to the FDA requesting permission for commercial distribution under Section 510(k) of the Federal Food, Drug, and Cosmetic Act, (or "FD&C Act") also referred to as a 510(k) clearance, or approval from the FDA of a premarket approval ("PMA") application. Both the 510(k) clearance and PMA processes can be resource intensive, expensive and lengthy, and require payment of significant user fees, unless an exemption is available. Device Classification Under the FD&C Act, medical devices are classified into one of three classes - Class I, Class II or Class III-depending on the degree of risk associated with each medical device and the extent of control needed to provide reasonable assurances with respect to safety and effectiveness. Class I devices are those for which safety and effectiveness can be reasonably assured by adherence to a set of regulations, referred to as General Controls, which require compliance with the applicable portions of the QSR, facility registration and product listing, reporting of adverse events and malfunctions and appropriate, truthful and non-misleading labeling and promotional materials. Some Class I devices, also called Class I reserved devices, also require premarket clearance by the FDA through the 510(k) premarket notification process described below. Most Class I products are exempt from the premarket notification requirements. Class II devices are those that are subject to the General Controls, as well as Special Controls, which can include performance standards, guidelines and postmarket surveillance. Most Class II devices are subject to premarket review and clearance by the FDA. Premarket review and clearance by the FDA for Class II devices is accomplished through the 510(k) premarket notification process. Under the 510(k) process, the manufacturer must submit to the FDA a premarket notification, demonstrating that the device is "substantially equivalent," as defined in the statute, to either: • • a device that was legally marketed prior to May 28, 1976, the date upon which the Medical Device Amendments of 1976 were enacted, or another commercially available, similar device that was cleared through the 510(k) process. To be "substantially equivalent," the proposed device must have the same intended use as the predicate device, and either have the same technological characteristics as the predicate device or have different technological characteristics and not raise different questions of safety or effectiveness than the predicate device. Clinical data are sometimes required to support substantial equivalence. After a 510(k) notice is submitted, the FDA determines whether to accept it for substantive review. If it lacks necessary information for substantive review, the FDA will refuse to accept the 510(k) notification. If it is accepted for filing, the FDA begins a substantive review. By statute, the FDA is required to complete its review of a 510(k) notification within 90 days of receiving the 510(k) notification. As a practical matter, clearance often takes longer, and clearance is never assured. Although many 510(k) premarket notifications are cleared without clinical data, the FDA may require further information, including clinical data, to make a determination regarding substantial equivalence, which may significantly prolong the review process. If the FDA agrees that the device is substantially equivalent, it will grant clearance to commercially market the device. 9 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. After a device receives 510(k) clearance, any modification, including modification to or deviation from design, manufacturing processes, materials, packaging and sterilization that could significantly affect its safety or effectiveness, or that would constitute a new or major change in its intended use, may require a new 510(k) clearance or, depending on the modification, could require a PMA application. The FDA requires each manufacturer to make this determination initially, but the FDA can review any such decision and can disagree with a manufacturer's determination. If the FDA requires a new 510(k) clearance or approval of a PMA application for any modifications to a previously cleared product, the applicant may be required to cease marketing or recall the modified device until clearance or approval is received. In addition, in these circumstances, the FDA can impose significant regulatory fines or penalties for failure to submit the requisite 510(k) or PMA application(s). If the FDA determines that the device is not "substantially equivalent" to a predicate device, or if the device is automatically classified into Class III, the device sponsor must then fulfill the much more rigorous premarketing requirements of the PMA approval process, or seek reclassification of the device through the de novo process. A manufacturer can also submit a petition for direct de novo review if the manufacturer is unable to identify an appropriate predicate device and the new device or new use of the device presents a moderate or low risk. Class III devices include devices deemed by the FDA to pose the greatest risk such as life-supporting or life-sustaining devices, or implantable devices, in addition to those deemed novel and not substantially equivalent following the 510(k) process. The safety and effectiveness of Class III devices cannot be reasonably assured solely by the General Controls and Special Controls described above. Therefore, these devices are subject to the PMA application process, which is generally more costly and time consuming than the 510(k) process. Through the PMA application process, the applicant must submit data and information demonstrating reasonable assurance of the safety and effectiveness of the device for its intended use to the FDA's satisfaction. Accordingly, a PMA application typically includes, but is not limited to, extensive technical information regarding device design and development, pre-clinical and clinical trial data, manufacturing information, labeling and financial disclosure information for the clinical investigators in device studies. The PMA application must provide valid scientific evidence that demonstrates to the FDA's satisfaction a reasonable assurance of the safety and effectiveness of the device for its intended use. The Orbera intragastric balloons are Class III devices. The OverStitch devices are Class II devices. We also sell accessory products, some of which are Class I. The Investigational Device Process In the U.S., absent certain limited exceptions, human clinical trials intended to support medical device clearance or approval require an Investigational Device Exemption ("IDE") application. Some types of studies deemed to present "non-significant risk" are deemed to have an approved IDE once certain requirements are addressed and IRB approval is obtained. If the device presents a "significant risk" to human health, as defined by the FDA, the sponsor must submit an IDE application to the FDA and obtain IDE approval prior to commencing the human clinical trials. The IDE application must be supported by appropriate data, such as animal and laboratory testing results, showing that it is safe to test the device in humans and that the testing protocol is scientifically sound. The IDE application must be approved in advance by the FDA for a specified number of subjects. Generally, clinical trials for a significant risk device may begin once the IDE application is approved by the FDA and the study protocol and informed consent are approved by appropriate institutional review boards at the clinical trial sites. There can be no assurance that submission of an IDE will result in the ability to commence clinical trials, and although the FDA's approval of an IDE allows clinical testing to go forward for a specified number of subjects, it does not bind the FDA to accept the results of the trial as sufficient to prove the product's safety and efficacy, even if the trial meets its intended success criteria. All clinical trials must be conducted in accordance with the FDA's IDE regulations that govern investigational device labeling, prohibit promotion and specify an array of recordkeeping, reporting and monitoring responsibilities of study sponsors and study investigators. Clinical trials must further comply with the FDA's regulations for institutional review board approval and for informed consent and other human subject protections. Required records and reports are subject to inspection by the FDA. The results of clinical testing may be unfavorable, or, even if the intended safety and efficacy success criteria are achieved, may not be considered sufficient for the FDA to grant marketing approval or clearance of a product. The commencement or completion of any clinical trial may be delayed or halted, or be inadequate to support approval of a PMA application or clearance of a 510(k), for numerous reasons, including, but not limited to, the following: • • • • the FDA or other regulatory authorities do not approve a clinical trial protocol or a clinical trial, or place a clinical trial on hold; patients do not enroll in clinical trials at the rate expected; patients do not comply with trial protocols; patient follow-up is not at the rate expected; 10 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. • • • • • • • • • • • • • patients experience adverse events; patients die during a clinical trial, even though their death may not be related to the products that are part of the trial; device malfunctions occur with unexpected frequency or potential adverse consequences; side effects or device malfunctions of similar products already in the market that change the FDA's view toward approval of new or similar PMAs or clearance of a 510(k) or result in the imposition of new requirements or testing; institutional review boards and third-party clinical investigators may delay or reject the trial protocol; third-party clinical investigators decline to participate in a trial or do not perform a trial on the anticipated schedule or consistent with the clinical trial protocol, investigator agreement, investigational plan, good clinical practices, the IDE regulations or other FDA or IRB requirements; third-party investigators are disqualified by the FDA; data collection, monitoring and analysis is not performed in a timely or accurate manner or consistent with the clinical trial protocol or investigational or statistical plans, or otherwise fail to comply with the IDE regulations governing responsibilities, records and reports of sponsors of clinical investigations; third-party clinical investigators have significant financial interests related to us or our study such that the FDA deems the study results unreliable, or the company or investigators fail to disclose such interests; regulatory inspections of our clinical trials or manufacturing facilities, which may, among other things, require us to undertake corrective action or suspend or terminate our clinical trials; changes in government regulations or administrative actions; the interim or final results of the clinical trial are inconclusive or unfavorable as to safety or efficacy; or the FDA concludes that our trial design is unreliable or inadequate to demonstrate safety and efficacy. The PMA Approval Process Following receipt of a PMA application, the FDA conducts an administrative review to determine whether the application is sufficiently complete to permit a substantive review. If it is not, the agency will refuse to file the PMA. If it is, the FDA will accept the application for filing and begin the review. The FDA, by statute and by regulation, has 180 days to review a filed PMA application, although the review of an application more often occurs over a significantly longer period of time. During this review period, the FDA may request additional information or clarification of information already provided, and the FDA may issue a major deficiency letter to the applicant, requesting the applicant's response to deficiencies communicated by the FDA. The FDA considers a PMA or PMA supplement to have been voluntarily withdrawn if an applicant fails to respond to an FDA request for information (e.g., major deficiency letter) within a total of 360 days. Before approving or denying a PMA, an FDA advisory committee may review the PMA at a public meeting and provide the FDA with the committee's recommendation on whether the FDA should approve the submission, approve it with specific conditions, or not approve it. Prior to approval of a PMA, the FDA may conduct a bioresearch monitoring inspection of the clinical trial data and clinical trial sites, and a QSR inspection of the manufacturing facility and processes. Overall, the FDA review of a PMA application is to take 180 days, although the review generally takes between one and three years, or longer. The FDA can delay, limit or deny approval of a PMA application for many reasons, including: • • • • the device may not be shown safe or effective to the FDA's satisfaction; the data from pre-clinical studies and/or clinical trials may be found unreliable or insufficient to support approval; the manufacturing process or facilities may not meet applicable requirements; and changes in FDA approval policies or adoption of new regulations may require additional data. If the FDA evaluation of a PMA is favorable, the FDA will issue either an approval letter, or an approvable letter, the latter of which usually contains a number of conditions that must be met in order to secure final approval of the PMA. When and if those conditions have been fulfilled to the satisfaction of the FDA, the agency will issue a PMA approval letter authorizing commercial marketing of the device, subject to the conditions of approval and the limitations established in the approval letter. 11 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. If the FDA's evaluation of a PMA application or manufacturing facilities is not favorable, the FDA will deny approval of the PMA or issue a not approvable letter. The FDA also may determine that additional tests or clinical trials are necessary, in which case the PMA approval may be delayed for several months or years while the trials are conducted and data are submitted in an amendment to the PMA, or the PMA is withdrawn and resubmitted when the data are available. The PMA process can be expensive, uncertain and lengthy and a number of devices for which FDA approval has been sought by other companies have never been approved by the FDA for marketing. New PMA applications or PMA supplements may be required for modification to the manufacturing process, equipment or facility, quality control procedures, sterilization, packaging, expiration date, labeling, device specifications, components, materials or design of a device that has been approved through the PMA process. PMA supplements often require submission of the same type of information as an initial PMA application, except that the supplement is limited to information needed to support any changes from the device covered by the approved PMA application and may or may not require as extensive technical or clinical data or the convening of an advisory panel, depending on the nature of the proposed change. In approving a PMA application, as a condition of approval, the FDA may also require some form of postmarket studies or postmarket surveillance, whereby the applicant follows certain patient groups for a number of years and makes periodic reports to the FDA on the clinical status of those patients when necessary to protect the public health or to provide additional or longer term safety and effectiveness data for the device. The FDA may require postmarket surveillance for certain devices approved under a PMA or cleared under a 510(k) notification, such as implants or life-supporting or life-sustaining devices used outside a device user facility, devices where the failure of which would be reasonably likely to have serious adverse health consequences, or devices expected to have significant use in pediatric populations. The FDA may also approve a PMA application with other post-approval conditions intended to ensure the safety and effectiveness of the device, such as, among other things, restrictions on labeling, promotion, sale, distribution and use. Pervasive and Continuing FDA Regulation After the FDA permits a device to enter commercial distribution, numerous regulatory requirements continue to apply. These include: • • • • • • the FDA's QSR, which requires manufacturers, including third party manufacturers, to follow stringent design, testing, production, control, supplier/contractor selection, complaint handling, documentation and other quality assurance procedures during all aspects of the manufacturing process; labeling regulations, unique device identification requirements and FDA prohibitions against the promotion of products for uncleared, unapproved or off-label uses; advertising and promotion requirements; restrictions on sale, distribution or use of a device; PMA annual reporting requirements; PMA approval or clearance of a 510(k) for product modifications; • medical device reporting ("MDR"), regulations, which require that manufacturers report to the FDA if their device may have caused or contributed to a death or serious injury or malfunctioned in a way that would likely cause or contribute to a death or serious injury if the malfunction were to recur; • medical device correction and removal reporting regulations, which require that manufacturers report to the FDA field corrections and product recalls or removals if undertaken to reduce a risk to health posed by the device or to remedy a violation of the U.S. Federal Food, Drug and Cosmetic Act that may present a risk to health; • • • recall requirements, including a mandatory recall if there is a reasonable probability that the device would cause serious adverse health consequences or death; unique device identifier and device tracking requirements; and post-market surveillance regulations, which apply when necessary to protect the public health or to provide additional safety and effectiveness data for the device. We have registered with the FDA as a medical device manufacturer and have obtained authorization to manufacture from the FDA. The FDA has broad post- market and regulatory enforcement powers. We are subject to unannounced inspections by 12 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. the FDA Office of Compliance within the Center for Devices and Radiological Health to determine our compliance with the QSR and other applicable regulations, and these inspections may include the manufacturing facilities of our suppliers. Fraud and Abuse Laws Our business is regulated by laws pertaining to healthcare fraud and abuse including anti-kickback laws and false claims laws. Violations of these laws are punishable by significant criminal and civil sanctions, including, in some instances, exclusion from participation in federal and state healthcare programs, such as Medicare and Medicaid. Anti-Kickback Statute Subject to a number of statutory exceptions, the federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or paying remuneration, directly or indirectly, in cash or in kind, in exchange for or to induce either the referral of an individual for, or the furnishing, recommending, purchasing, leasing, ordering, or arranging for, a good or service for which payment may be made under a federal healthcare program such as Medicare and Medicaid. The term "remuneration" has been broadly interpreted to include anything of value, including payments to physicians or other providers, gifts, discounts, the furnishing of supplies or equipment, credit arrangements, waiver of payments and providing anything of value at less than fair market value. The Office of the Inspector General ("OIG") of the U.S. Department of Health and Human Services and the U.S. Department of Justice ("DOJ") are responsible for enforcing the federal Anti-Kickback Statute and the OIG is primarily responsible for identifying fraud and abuse activities affecting government healthcare programs. Penalties for violating the federal Anti-Kickback Statute include substantial criminal fines and/or imprisonment, substantial civil fines and possible exclusion from participation in federal healthcare programs such as Medicare and Medicaid. Many states have adopted prohibitions similar to the federal Anti-Kickback Statute, some of which apply to the referral of patients for healthcare services reimbursed by any source, not only by government healthcare programs such as the Medicare and Medicaid programs and do not include comparable exceptions to those provided by the federal Anti-Kickback Statute. The OIG has issued safe harbor regulations that identify activities and business relationships that are not treated as offenses under the federal Anti-Kickback Statute. These safe harbors exist for various types of arrangements, including certain investment interests, leases, personal service arrangements, discounts and management contracts. The failure of a particular activity to comply with all requirements of an applicable safe harbor regulation does not mean that the activity violates the federal Anti-Kickback Statute or that prosecution will be pursued. However, activities and business arrangements that do not fully satisfy each applicable safe harbor may result in increased scrutiny by government enforcement authorities such as the OIG. In recent years, the federal government and several states have enacted legislation requiring biotechnology, pharmaceutical and medical device companies to establish marketing compliance programs and file periodic reports on sales, marketing and other activities. Similar legislation is being considered in other states. Many of these requirements are new and uncertain, and available guidance is limited. Federal False Claims Act The federal False Claims Act ("FCA") prohibits knowingly filing or causing the filing of a false claim or the knowing use of false statements to obtain payment from the federal government. A claim that is filed pursuant to an unlawful kickback may be a false claim under this law and, in a number of cases, manufacturers of medical products have entered into settlements based on FCA allegations that their financial relationships with customers "caused" these customers to submit false claims. When an entity is determined to have violated the FCA, it may be required to pay up to three times the actual damages sustained by the government, plus mandatory civil penalties for each separate false claim. Private individuals can file suits under the FCA on behalf of the government. These lawsuits are known as "qui tam" actions, and the individuals bringing such suits, sometimes known as "relators" or, more commonly, "whistleblowers," may share in any amounts paid by the entity to the government in fines or settlement. Since complaints related to “qui tam” actions are initially filed under seal, the action may be pending for some time before a defendant is even aware of such action. HIPAA The Health Insurance Portability and Accountability Act of 1996 ("HIPAA"), created two new federal crimes: healthcare fraud and false statements relating to healthcare matters. The healthcare fraud statute prohibits knowingly and willfully executing, or attempting to execute, a scheme to defraud any healthcare benefit program, including private payers. A violation of this statute is a felony and may result in fines, imprisonment or exclusion from government-sponsored programs. The false statements statute prohibits knowingly and willfully falsifying, concealing or covering up a material fact or making any 13 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. materially false, fictitious or fraudulent statement in connection with the delivery of or payment for healthcare benefits, items or services. A violation of this statute is a felony and may result in fines or imprisonment. HIPAA also protects the security and privacy of individually identifiable health information maintained or transmitted by healthcare providers, health plans and healthcare clearinghouses and their business associates. HIPAA restricts the use and disclosure of patient health information, including patient records. Although we believe that HIPAA does not apply directly to us, most of our customers have significant obligations under HIPAA, and we intend to cooperate with customers and others to ensure compliance with HIPAA with respect to patient information. Failure to comply with HIPAA obligations can result in civil fines and/or criminal penalties. Some states have also enacted rigorous laws or regulations protecting the security and privacy of patient information. Healthcare Reform and Compliance In March 2010, the U.S. Congress enacted the Patient Protection and Affordable Care Act and the Health Care and Education Reconciliation Act of 2010 ("ACA"). The Physician Payments Sunshine Act ("PPSA"), which is part of the ACA, requires manufacturers of drugs, biologics, devices and medical supplies covered under Medicare and Medicaid to record any transfers of value to physicians and teaching hospitals and to report this data to Centers for Medicare & Medicaid Services, for subsequent public disclosure. Similar reporting requirements have also been enacted in several states, and an increasing number of countries worldwide either have adopted or are considering similar laws requiring transparency of interactions with healthcare professionals. In addition to reporting, some states such as Massachusetts and Vermont impose an outright ban on certain gifts to physicians. Failure to report may result in civil or criminal fines and/or penalties. International Regulation Our business is also subject to regulation in each of the foreign countries in which our products are sold. Many of the regulations applicable to our products in these countries are similar to those of the FDA. The European Union ("EU") requires that Apollo Endosurgery’s devices comply with the Medical Device Directive. The Medical Device Directive is being replaced by the Regulation 2017/745 on Medical Devices, or the MDR, effective May 26, 2020. The MDR contains additional requirements beyond those required to comply with the directives they replace, and often require the submission of more detailed data to support approval. Notably, the requirements for clinical evidence are more rigorous. All affected companies must comply with the MDR by May 26, 2020, specifically the transition requirements dealing with registration, post-market surveillance, market surveillance and vigilance reporting. To support compliance under the MDR, we intend to obtain additional clinical data for Orbera 365 In order to place a medical device on the European market, a CE mark must be obtained. To obtain a CE Mark, medical devices must meet certain minimum standards of safety and quality and, depending on which class of medical device they fall into, as such classes are defined in the MDR for the new regime, they may need to undergo an appropriate conformity assessment procedure conducted by a Notified Body. A Notified Body will, amongst other things, assess the quality management systems of the manufacturer and verify that the relevant device conforms to the requirements set out in the relevant legislation. Once the appropriate conformity assessment procedure for the medical device has been completed, a declaration of conformity will be created and the manufacturer will affix the CE mark to the device. The device can then be marketed throughout the European Economic Area (being the Member States of the EU, together with Norway, Iceland and Liechtenstein). Notified bodies may perform surveillance and unannounced audits at the manufacturer and critical suppliers with respect to the devices covered by the certificates issued by them. If non-conformities raised during the audits are not remedied in a timely manner by the manufacturer, the notified body may (partially or wholly) suspend or withdraw the certificate concerned. In the EU, we are also required to maintain certain ISO certifications in order to sell products. We are also subject to regulations and periodic review from various regulatory bodies in other countries where our products are sold. Lack of regulatory compliance in any of these jurisdictions could limit our ability to distribute products in these countries. We are also subject to foreign laws and regulations governing the marketing and promotion of our products including transparency reporting obligations. Foreign Corrupt Practices Act The U.S. Foreign Corrupt Practices Act ("FCPA") and similar worldwide anti-bribery laws in non-U.S. jurisdictions generally prohibit companies and their intermediaries from making improper payments to foreign government officials for the purpose of obtaining or retaining business. Many of our customer relationships outside of the U.S. are, either directly or indirectly, with governmental entities and employees (such as physicians at state-owned or state-operated hospitals) and are therefore subject to various anti-bribery laws. 14 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Other Regulations We are also subject to various international, federal, state and local laws and regulations relating to such matters as safe working conditions, laboratory and manufacturing practices and the use, handling and disposal of hazardous or potentially hazardous substances used in connection with our research and development and manufacturing activities. Specifically, the manufacture of our products is subject to compliance with various international and federal laws and regulations and by various foreign, state and local agencies. Employees As of December 31, 2019, we had a total of 217 full-time employees. None of our U.S. employees are represented by a labor union or subject to a collective bargaining agreement. Our non-U.S. employment contracts comply with the applicable country mandated collective agreement in the locations where we operate. We have never experienced any work stoppage and consider our relations with our employees to be good. Available Information We file or furnish pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended, as applicable, our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K, amendments to those reports, proxy statements and other information electronically with the SEC. Through a link on our website, we make copies of our periodic and current reports, amendments to those reports, proxy statements and other information available, free of charge, as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. Information found on, or accessible through, our website is not part of, and is not incorporated into, this Annual Report on Form 10-K. ITEM 1A. RISK FACTORS We have identified the following additional risks and uncertainties that may have a material adverse effect on our business, financial condition or results of operations. Investors should carefully consider the risks described below before making an investment decision. Our business faces significant risks and the risks described below may not be the only risks we face. Additional risks not presently known to us or that we currently believe are immaterial may also significantly impair our business operations. If any of these risks occur, our business, results of operations or financial condition could suffer, the market price of our common stock could decline and you could lose all or part of your investment in our common stock. Risks Related to Our Business Our business will be adversely affected by the effects of the ongoing COVID-19 pandemic. In December 2019, a novel strain of coronavirus, SARS-CoV-2, was reported to have surfaced in Wuhan, China. Since then, SARS-CoV-2, and the resulting disease COVID-19 has spread to multiple countries, including the United States and all of the primary markets where we conduct business. On March 10, 2020, the World Health Organization declared the COVID-19 outbreak a pandemic, and the U.S. government imposed travel restrictions on travel between the United States and Europe for a 30-day period. Further, on March 13, 2020, the President of the United States declared the COVID-19 pandemic a national emergency, invoking powers under the Stafford Act, the legislation that directs federal emergency disaster response. Several states and local jurisdictions have imposed, and others in the future may impose, "shelter-in-place" orders, quarantines, executive orders and similar government orders and restrictions for their residents to control the spread of COVID-19. Such orders or restrictions, and the perception that such orders or restrictions could occur, have resulted in business closures, work stoppages, slowdowns and delays, work-from-home policies, travel restrictions and cancellation of events, among other effects. We continue to monitor our operations and government mandates and may elect or be required to temporarily close our offices to protect our employees, and limit our access to customers and limit customer use of our products as they are required to prioritize resources to address the public healthcare needs arising from the COVID-19 pandemic. The disruptions to our activities and operations will negatively impact our business, operating results and financial condition. There is a risk that government actions will not be effective at containing COVID-19, and that government actions, including the orders and restrictions described above, that are intended to contain the spread of COVID-19 will have a devastating negative impact on the world economy at large, in which case the risks to our sales, operating results and financial condition described herein would be elevated significantly. The duration of COVID-19's impact on our business may be difficult to assess or predict. The widespread pandemic has resulted, and may continue to result for an extended period, in significant disruption of global financial markets, reducing our ability to access capital, which would negatively affect our liquidity. In addition, if the COVID-19 pandemic results in an economic recession, it would materially affect our sales and our ability to continue as a going concern. A prolonged economic contraction or recession may also result in employer layoffs of their employees in markets where we conduct business, which could result in lower procedure demand. In particular, as certain of the procedures that use our products have limited 15 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. reimbursement and require patients to pay for the procedures in whole or in part, a reduction in employment would reduce utilization and sales of our products. Restrictions on the ability to travel, social distancing policies, orders and restriction, including those described above, and recommendations and fears of COVID-19 spreading within medical centers has caused both patients and providers to delay or cancel procedures that use our devices. We are unable to accurately predict when these policies, orders and restrictions will be relaxed or lifted, and there can be no assurances that patients or providers will restart procedures that use our devices upon termination of these policies, orders and restrictions, particularly if there remains any continued community outbreak of COVID-19. Further, quarantines or government reaction or shutdowns for COVID-19 could disrupt our supply chain. Travel and import restrictions may also disrupt our ability to manufacture or distribute our devices. Any import or export or other cargo restrictions related to our products or the raw materials used to manufacture our products would restrict our ability to manufacture and ship products and harm our business, financial condition and results of operations. Our key personnel and other employees could also be affected by COVID-19, potentially reducing their availability, and an outbreak such as COVID-19 or the procedures we take to mitigate its effect on our workforce could reduce the efficiency of our operations or prove insufficient. We may delay or reduce certain capital spending and related projects until the travel and logistical impacts of COVID-19 are lifted, which will delay the completion of such projects. In addition, the conduct of clinical trials required to maintain the regulatory status of certain of our products, such as the Orbera365 CE post approval study, may be affected by the COVID-19 pandemic. Site initiation and patient enrollment may be delayed due to prioritization of hospital resources toward the COVID- 19 outbreak. Some patients may not be able to comply with clinical trial protocols if quarantines impede patient movement or interrupt healthcare services. Our sales and marketing personnel often rely on in-person and onsite access to healthcare providers which is currently restricted as hospitals reduce access to essential personnel only. These restrictions have harmed our sales and marketing efforts, and continued restrictions would have a negative impact on our sales and results of operations. An increase of COVID-19-related hospital admissions may overload hospitals with unexpected patients, thereby delaying further procedures that use our devices but that are deemed elective by the hospital. In addition, we have made temporary salary and work hour reductions and may, in the future, take further actions including further reductions to salary and work hours, furloughs, restructuring or layoffs which may negatively impact our workforce and our business. The global outbreak of COVID-19 continues to rapidly evolve. The ultimate impact of the COVID-19 outbreak is highly uncertain and subject to change. We do not yet know the full extent of potential delays or impacts on our business or the global economy as a whole. However, these effects have harmed our business, financial condition and results of operations in the near term and could have a continuing material impact on our operations, sales and ability to continue as a going concern. We have incurred significant operating losses since inception and may not be able to achieve profitability. We have incurred net losses since our inception in 2005. For the years ended December 31, 2019 and 2018, we had net losses of $27.4 million and $45.8 million, respectively. As of December 31, 2019, we had an accumulated deficit of $250.2 million. To date, we have funded our operations primarily through equity offerings, the issuance of debt instruments, and from sales of our products. We have devoted substantially all of our resources to the acquisition of products, the research and development of products, sales and marketing activities and clinical and regulatory initiatives to obtain approvals for our products. Our ability to generate sufficient revenue from our existing products, and to transition to profitability and generate consistent positive cash flows is uncertain. We may need to raise additional funds in the future, and such funds may not be available on a timely basis, or at all. We expect that our operating expenses may increase as we continue to build our commercial infrastructure, develop, enhance and commercialize our products and incur additional costs associated with being a public company. As a result, we may incur operating losses for the foreseeable future and may never achieve profitability. Our long-term growth depends on our ability to successfully develop the therapeutic endoscopy market and successfully commercialize our Endoscopy products. It is important to our business that we continue to build a market for therapeutic endoscopy procedures within the gastroenterology and bariatric communities. Our Endoscopy products offer non-surgical and less-invasive solutions and technology that enable new options for physicians treating their patients who suffer from a variety of gastrointestinal conditions, including obesity. However, this is a new market and developing this market is expensive and time-consuming and may not be successful due to a variety of factors including lack of physician adoption, patient demand, or both. Even if we are successful in developing additional products in the Endoscopy market, the success of any new product offering or enhancement to an existing product will depend on several factors, including our ability to: • • properly identify and anticipate physician and patient needs; effectively train physicians on how to use our products and achieve good patient outcomes; 16 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. • • • • effectively communicate with physicians, payors and patients and educate them on the benefits of Endoscopy procedures; achieve adoption of procedures for the use of our products in a timely manner, including for procedures that may not receive third party insurance coverage or reimbursement; develop clinical data that demonstrate the safety and efficacy of the procedures that use our products; obtain the necessary regulatory clearances or approvals for new products or product enhancements; • market new devices or modified products in compliance with the regulations of the FDA and other applicable regulatory authorities; • • receive adequate coverage and reimbursement for procedures performed with our products; and train our sales and marketing team to effectively support our market development efforts. If we are unsuccessful in developing and commercializing the therapeutic endoscopy market, our ability to increase our revenue will be impaired and our business, results of operations, financial condition and prospects will be materially adversely affected. Adverse U.S. and international economic conditions may reduce consumer demand for our products, causing our sales and profitability to suffer. Adverse economic conditions in the U.S. and international markets, including the economic contraction resulting in part from the COVID-19 pandemic, may negatively affect our revenues and operating results. Our Endoscopy products, such as the Intragastric Balloon products, have limited reimbursement, and in most cases are not reimbursable by governmental or other health care plans and instead are partially or wholly paid for directly by patients. Sales of our products may be negatively affected by adverse economic conditions impacting consumer spending, including among others, increased taxation, higher unemployment, lower consumer confidence in the economy, disasters or disease outbreaks, such as the COVID-19 pandemic, higher consumer debt levels, lower availability of consumer credit, higher interest rates and hardships relating to declines in the housing and stock markets which have historically caused consumers to reassess their spending choices and reduce their likelihood to pursue elective surgical procedures. Any reduced consumer demand due to adverse economic or market conditions could have a material adverse effect on our business, cause sales and profitability to suffer, reduce operating cash flow and result in a decline in the price of our common stock. Adverse economic and market conditions could also have a negative impact on others, such as creditors, third-party contractors and suppliers, causing them to fail to meet their obligations to us. Our future growth depends on physician adoption and recommendation of procedures utilizing our products. Our ability to sell our products depends on the willingness of our physician customers to adopt our products and to recommend corresponding procedures to their patients. Physicians may not adopt our products unless they determine that they have the necessary skills to use our products and, based on their own experience, clinical data, communications from regulatory authorities and published peer-reviewed research, that our products provide a safe and effective treatment option. Even if we are able to raise favorable awareness among physicians, physicians may be hesitant to change their medical treatment practices and may be hesitant to recommend procedures that utilize our products for a variety of reasons, including: • • • • • • • existing preferences for competitor products or with alternative medical procedures and a general reluctance to change to or use new products or procedures; lack of experience or proficiency with our products; time and skill commitment that may be necessary to gain familiarity with a new product or new treatment; a perception that our products are unproven, unsafe, ineffective, experimental or too expensive; reluctance for a related hospital or healthcare facility to approve the introduction of a new product or procedure; a preference for an alternative procedure that may afford a physician or a related hospital or healthcare facility greater remuneration; and, the development of new weight loss treatment options, including pharmacological treatments, that are less costly, less invasive, or more effective. 17 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Our future growth depends on patient awareness of and demand for procedures that use our products. The procedures that utilize our products are generally elective in nature and demand for our products is driven significantly by patient awareness and preference for the procedures that use our products. We provide patient education materials about our products and related procedures where allowed by local law and consistent with our product regulatory indications through various forms of media. However, the general media, social media and other forms of media outside of our control as well as competing organizations may distribute information that presents our products and related procedures as being unproven, unsafe, ineffective, experimental, or otherwise unfavorable to our products and related procedures. If patient awareness and preference for procedures is not sufficient or is not positive, our future growth will be impaired. In addition, our future growth will be impacted by the level of patient satisfaction achieved from procedures that use our products. If patients who undergo treatment using our product are not satisfied with their results, our reputation and that of our products may suffer. Even if we are able to raise favorable awareness among patients, patients may be hesitant to proceed with a medical treatment for various reasons including: • • • • • • perception that our products are unproven or experimental; reluctance to undergo a medical procedure; previous long-term failure with other weight loss programs; reluctance of a prospective patient to commit to long-term lifestyle changes; out of pocket cost for an elective procedure; and alternative treatments that are perceived to be more effective or less expensive. We may not be able to successfully introduce new products or indications to the market in a timely manner. Our future financial performance will depend in part on our ability to develop and manufacture new products or to acquire new products in a cost-effective manner, to introduce these products to the market on a timely basis and to achieve market acceptance of these products. Factors which may result in delays of new product introductions include capital constraints, research and development delays, lack of personnel with sufficient experience or competence, delays in acquiring regulatory approvals or clearances, including obtaining regulatory approval for new indications for use or delays in closing acquisition transactions. Future product introductions may fail to achieve expected levels of market acceptance including physician adoption, patient awareness or both. Factors impacting the level of market acceptance include the timeliness of our product introductions, the effectiveness of medical education efforts, the effectiveness of patient awareness and educational activities, successful product pricing strategies, available financial and technological resources for product promotion and development, the ability to show clinical benefit from future products, the scope of the indicated use for new products and the availability of coverage and reimbursement for procedures that use future products. The misuse or off-label use of our products may harm our image in the marketplace, result in injuries that lead to product liability suits or result in costly investigations and sanctions by regulatory bodies if we are deemed to have engaged in the promotion of these uses, any of which could be costly to our business. The products we currently market have been approved or cleared by the FDA for specific indications. We train our marketing and direct sales force to not promote our products for uses outside of the FDA-approved or cleared indications for use, known as "off-label uses." We cannot, however, prevent a physician from using our products off-label, when in the physician's independent professional medical judgment he or she deems it appropriate. There may be increased risk of injury to patients if physicians attempt to use our products off-label. Furthermore, the use of our products for indications other than those approved or cleared by the FDA or any foreign regulatory body may not effectively treat such conditions, which could harm our reputation in the marketplace among physicians and patients. Physicians may also misuse our products, use improper techniques, ignore or disregard information provided in training or product labeling, or fail to obtain adequate training, potentially leading to injury and an increased risk of product liability. If our products are misused or used with improper technique, we may become subject to costly litigation by our customers or their patients. Product liability claims could divert management's attention from our core business, be expensive to defend, and result in sizable damage awards against us that may not be covered by insurance. Some of our products have cleared indications for general use and the FDA or foreign regulatory bodies may request clinical evidence to support a specific intended use, or determine that promotional materials or training relating to a particular procedure is off-label promotion. If the FDA or any foreign regulatory body determines that our promotional materials or training constitute promotion of an off-label use, it could request that we modify our training or promotional materials or we could be subject to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine or criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our business activities to 18 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. constitute promotion of an off-label use, which could result in significant penalties, including, but not limited to, criminal, civil and administrative penalties, damages, fines, disgorgement, exclusion from participation in government healthcare programs and the curtailment of our operations. Any of these events could significantly harm our business and results of operations and cause our stock price to decline. If we are unable to manage and maintain our direct sales and marketing organizations, we may not be able to generate anticipated revenue. Our operating results are directly dependent upon the sales and marketing efforts of our employees. If our direct sales representatives fail to adequately promote, market and sell our products, our sales may suffer. In order to generate our anticipated sales, we will need to maintain a qualified and well-trained direct sales organization. As a result, our future success will depend largely on our ability to hire, train, retain and motivate skilled sales managers and direct sales representatives. Because of the competition for their services, we cannot assure you we will be able to hire and retain direct sales representatives on favorable or commercially reasonable terms, if at all. Failure to hire or retain qualified sales representatives would prevent us from expanding our business and generating sales. Additionally, new hires require training and take time before they achieve full productivity. If we fail to train new hires adequately, new hires may not become as productive as may be necessary to maintain or increase our sales and we may not be able to effectively commercialize our products, which would adversely affect our business, results of operations and financial condition. In addition, we may change our sales approach in certain markets from direct sales to healthcare providers to sales to distributors who then resell our products. If we were to change our sales approach in a given market, our product sales price in the affected market would be reduced which would lower our revenue and gross margin and the resulting reduction in our operating expense may not be sufficient to offset this reduction in our gross margin. We are dependent on certain suppliers, vendors and manufacturers, and supply or service disruptions could materially adversely affect our business and future growth. If the supply of materials from our suppliers or provision of services from our vendors were to be interrupted or if we experience delays or interruptions from our manufacturers, including due to the COVID-19 pandemic, replacement or alternative sources might not be readily obtainable. In particular, the products which together comprise our ESS products are sourced from a variety of suppliers and manufacturers, and these suppliers and manufacturers further depend on many component providers. In addition, our ESS products are sterilized by a single-source contract sterilizer. If our suppliers experience unanticipated quality issues or fail to supply components that meet design specifications, or if our contract sterilizer experiences delays or shutdowns, we may experience manufacturing delays or product quality issues that may erode customer confidence in our products and negatively affect our sales. As ESS product sales increase, we have experienced times of temporary supply and vendor disruption for a variety of reasons and this has caused delays in our fulfillment of customer orders. For example, we have experienced production and inventory shortages for OverStitch as a result of supply shortages from component suppliers from time to time. In addition, our sterilization vendor's operation was suspended beginning in December 2019 to bring their operation into compliance with new pollution control requirements. There can be no assurance that our sterilization vendor will be able to meet these new requirements and restart their operations in the near term or at all or stay in compliance. To mitigate this risk, we are working to qualify an alternative sterilization vendor. There is also no assurance that this qualification effort will be successful or timely. Continued interruptions or shortages in these inputs or services, or future unexpected interruptions and shortages, could harm our business, financial condition and results of operations. If such a condition were to persist, our business could suffer as our reputation with customers could be damaged and eventually could lead to reduced future demand for our products. An inability to continue to source materials or components, or receive services, from any of our suppliers, vendors or manufacturers could be due to reasons outside of our direct control, such as regulatory actions or requirements affecting the supplier, adverse financial or other strategic developments experienced by a supplier or manufacturer, labor disputes or shortages at the supplier and unexpected demands or quality issues. We may also face disputes with our current or previous suppliers and vendors. In any of these cases, we could face a delay of several months to identify and qualify alternative suppliers and service providers with regulatory authorities, as we do not currently have supplier or vendor transition plans. In addition, the failure of our third-party suppliers and service providers to maintain acceptable quality requirements could result in the recall of our products. Manufacturing of our products requires capital equipment and a well-trained workforce. The sourcing of new manufacturing or supply capacity can require significant lead time. If demand increases faster than we expect, or if we are unable to produce the quantity of goods that we expect with our current suppliers and manufacturers, we will not be able to adequately address demand for our products and our revenues and results of operations would suffer. If we are required to replace a vendor, a new or supplemental filing with applicable regulatory authorities may be required before the product could be sold with a material or component supplied by a new supplier or manufacturer. The regulatory approval process may take a substantial period of time and we cannot assure investors that we would be able to obtain the necessary regulatory approval for a new material to be used in products on a timely basis, if at all. This could create supply 19 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. disruptions that would materially adversely affect our business. For example, in instances where we are changing our supplier of a key component of a product, we will need to ensure that we have sufficient supply of the component while the change is reviewed by regulatory authorities. We are dependent on warehouses and service providers in the U.S., Brazil, Australia and the Netherlands for product logistics, order fulfillment and distribution support that are owned and operated by third parties. Our ability to supply products to our customers in a timely manner and at acceptable commercial terms could be disrupted or continue to be disrupted by factors such as fire, earthquake or any other natural disaster, work stoppages or information technology system failures that occur at these third-party warehouse and service providers. It is difficult to forecast future performance, which may cause operational delays or inefficiency. We create internal operational forecasts to determine requirements for components and materials used in the manufacture of our products and to make production plans. Our limited operating history and commercial experience, as well as the ongoing COVID-19 pandemic, may make it difficult for us to accurately predict future production requirements. If we forecast inaccurately, this may cause us to have shortfalls or backorders that may negatively impact our reputation with customers and cause them to seek alternative products, or could lead us to have excessive inventory, scrap or similar operational and financial inefficiency that could harm our business. We compete or may compete in the future against other companies, some of which have longer operating histories, more established products and greater resources, which may prevent us from achieving significant market penetration or improved operating results. Our industry is highly competitive, subject to change and significantly affected by new product introductions and activities of other industry participants. These participants may enjoy several competitive advantages, including: • • • • • greater financial and human capital resources; significantly greater name recognition; established relationships with physicians, referring physicians, customers and third-party payors; additional lines of products, and the ability to offer rebates or bundle products to offer greater discounts or incentives to gain a competitive advantage; and established sales, marketing and worldwide distribution networks. If another company successfully develops an approach for the treatment of gastrointestinal conditions, including obesity, that is less invasive or more effective than our current product offerings, sales of our products would be significantly and adversely affected. We may be unable to successfully integrate or expand operations and processes in connection with acquisitions or we may be unable to efficiently transfer divested assets. In the future, should we grow or acquire new assets or businesses, we expect to incrementally hire and train new personnel and implement appropriate financial and managerial controls, systems and procedures in order to effectively manage our growth and integrate newly acquired operations and processes. In the future, should we divest assets or portions of our business, we will need to implement financial and managerial controls and procedures to efficiently manage the divestiture of such assets and the transition of such business to an acquirer. Failure to successfully manage the integration of newly acquired assets or business or to efficiently transition divested assets to an acquirer could adversely affect our business. We face the risk of product liability claims that could be expensive, divert management's attention and harm our reputation and business. We may not be able to maintain adequate product liability insurance. Our business exposes us to the risk of product liability claims that are inherent in the testing, manufacturing and marketing of medical devices and drug products. This risk exists even if a device or product is approved or cleared for commercial sale by the FDA and manufactured in facilities regulated by the FDA, or an applicable foreign regulatory authority. Our products and product candidates are designed to affect important bodily functions and processes. Any side effects, manufacturing defects, misuse or abuse associated with our products or our product candidates could result in patient injury or death. The medical device industry has historically been subject to extensive litigation over product liability claims, and we cannot offer any assurance that we will not face product liability suits. We may be subject to product liability claims if our products contribute to, or merely appear to or are alleged to have contributed to, patient injury or death. In addition, an injury that is caused by the 20 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. activities of our suppliers, such as those who provide us with components and raw materials, may be the basis for a claim against us. Further, because we are obligated to continue providing certain transition services, including manufacturing and distribution support, to ReShape for our divested Surgical Product line, we may be subject to product liability claims from sales of Surgical products by ReShape, over which we have limited to no control. Product liability claims may be brought against us by patients and their family members, health care providers or others selling or otherwise coming into contact with our products or product candidates, among others. If we cannot successfully defend ourself against product liability claims, we will incur substantial liabilities and reputational harm. In addition, regardless of merit or eventual outcome, product liability claims may result in: • • • • • • • • • litigation costs; distraction of management's attention from our primary business; the inability to commercialize our products or, if approved or cleared, our product candidates; decreased demand for our products or, if approved or cleared, product candidates; impairment of our business reputation; product recall or withdrawal from the market; withdrawal of clinical trial participants; substantial monetary awards to patients or other claimants; or loss of revenue. While we may attempt to manage our product liability exposure by proactively recalling or withdrawing from the market any defective products, any recall or market withdrawal of our products may delay the supply of those products to our customers and may impact our reputation. We can provide no assurance that we will be successful in initiating appropriate market recall or market withdrawal efforts that may be required in the future or that these efforts will have the intended effect of preventing product malfunctions and the accompanying product liability that may result. Such recalls and withdrawals may also be used by our competitors to harm our reputation for safety or be perceived by patients as a safety risk when considering the use of our products, either of which could have an adverse effect on our business. In addition, although we maintain product liability and clinical study liability insurance that we believe is appropriate, this insurance is subject to deductibles and coverage limitations. Our current product liability insurance may not continue to be available to us on acceptable terms, if at all, and, if available, coverage may not be adequate to protect us against any future product liability claims. If we are unable to obtain insurance at an acceptable cost or on acceptable terms with adequate coverage or otherwise protect against potential product liability claims, we will be exposed to significant liabilities, which may harm our business. A product liability claim, recall or other claim with respect to uninsured liabilities or for amounts in excess of insured liabilities could have a material adverse effect on our business, financial condition and results of operations. If our facilities or the facility of a supplier become inoperable, we will be unable to continue to research, develop, manufacture and commercialize our products and, as a result, our business will be harmed. We do not have redundant facilities. We perform substantially all of our manufacturing in a single location in Costa Rica or at contract manufacturer locations in the United States. Any manufacturing facility and equipment would be costly to replace and would require substantial lead time to repair or replace. Manufacturing facilities may be harmed or rendered inoperable by natural or man-made disasters, including, but not limited to, flooding, fire, earthquakes, volcanic activity and power outages, which may render it difficult or impossible for us to perform our research, development, manufacturing and commercialization activities for some period of time. The inability to perform those activities, combined with our limited inventory of reserve raw materials and finished product, may result in the inability to continue manufacturing our products during such periods and the loss of customers, potential liabilities under our supply agreement with ReShape for the manufacture of Surgical products or harm to our reputation. Although we possess insurance for damage to our property and the disruption of our business, this insurance may not be sufficient to cover all of our potential losses and this insurance may not continue to be available to us on acceptable terms, or at all. Our business and operations would suffer in the event of system failures, security breaches or cyber-attacks Our computer systems, as well as those of various third-parties on which we rely, including those of contractors, consultants, and law and accounting firms, may sustain damage from computer viruses, unauthorized access, data breaches, phishing attacks, cyber criminals, natural disasters, terrorism, war and telecommunication and electrical failures. We rely on our third-party providers to implement effective security measures and identify and correct for any such failures, deficiencies, or 21 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. breaches. The risk of a security breach or disruption, particularly through cyber-attacks or cyber intrusion, including by computer hackers, foreign governments, and cyber terrorists, has generally increased as the number, intensity, and sophistication of attempted attacks and intrusions from around the world have increased. We may in the future experience material system failures or security breaches that could cause interruptions in our operations or result in material disruption of our product development programs. To the extent that any disruption or security breach were to result in a loss of or damage to our data or applications, or inappropriate disclosure of personal, confidential or proprietary information we could incur liability. If we experience significant disruptions in our or our third-party service providers' information technology systems, our business may be adversely affected. We depend on information technology systems for the efficient functioning of our business, including but not limited to accounting, data storage, compliance, sales operations, inventory management and product support applications. A number of information technology systems in use to support our business operations are owned and/or operated by third-party service providers over whom we have no or very limited control, and upon whom we have to rely to maintain business continuity procedures and adequate security controls to ensure high availability of their information technology systems and to protect our proprietary information. While we will attempt to mitigate interruptions, they could still occur and disrupt our operations, including our ability to timely ship and track product orders, project inventory requirements, manage our supply chain and otherwise adequately service our customers. In the event we experience significant disruptions to our information technology systems, we may not be able to repair our systems in an efficient and timely manner. Accordingly, such events may disrupt or reduce the efficiency of our entire operation and have a material adverse effect on our results of operations and cash flows. From time to time, we perform business improvements or infrastructure modernizations or use service providers for key systems and processes. If any of these initiatives are not successfully or efficiently implemented or maintained, they could adversely affect our business and our internal control over financial reporting. The ability to protect our or our third-party service providers' information systems and electronic transmissions of sensitive and/or proprietary data from data corruption, cyber-based attacks, security breaches or privacy violations is critical to the success of our business. We rely on information technology networks and systems, including the Internet, to securely process, transmit and store electronic information, including personal information of our customers and prospective product end-users. A security breach of this infrastructure, including physical or electronic break-ins, computer viruses, malware attacks by hackers and similar breaches, may cause all or portions of our or our third-party providers' systems to be unavailable, create system disruptions or shutdowns, and lead to erasure of critical data and software or unauthorized disclosure of confidential information. We invest in security technology to protect our data against risks of data security breaches and cyber-attacks, and we have implemented solutions, processes, and procedures to help mitigate these risks at various locations, such as encryption, virus protection, security firewalls and information security and privacy policies. Nonetheless, information technology and infrastructure which we rely upon may be subject to attacks by hackers and may be breached due to inadequate protective measures undertaken, human errors or omissions, malfeasance or other disruptions. The age of our or our third-party providers' information technology systems, as well as the level of protection and business continuity or disaster recovery capability, varies significantly by application software and third-party service provider, and there can be no guarantee that any such measures, to the extent they are in place, will be effective. In addition, a security breach or privacy violation that leads to disclosure of consumer information (including personally identifiable information, protected health information, or personal data of EU residents) could harm our reputation, compel us to comply with disparate federal, state and foreign breach notification laws and otherwise subject us to liability under laws that protect personal data, resulting in increased costs or loss of revenue. If we or our third-party providers are unable to prevent security breaches or privacy violations or implement satisfactory remedial measures, our operations could be disrupted, we may be subject to additional legal claims or proceedings, or we may suffer loss of reputation, financial loss and other regulatory penalties, which could have a material adverse impact on our business, financial condition and results of operations. Hackers and other cyber criminals are using increasingly sophisticated and constantly evolving techniques, and we may need to expend substantial additional resources to continue to protect against potential security breaches or to address problems caused by such attacks or any breach of our safeguards. In addition, a data security breach could distract management or other key personnel from performing their primary operational duties, impair our ability to transact business with our customers, lose access to critical data or systems, or compromise confidential information including trade secrets and other intellectual property, any of which may harm our competitive position, require us to allocate more resources to improved security technologies, or otherwise adversely affect our business. 22 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. In addition, the interpretation and application of consumer and data protection laws in the U.S., Europe and elsewhere are often uncertain, contradictory and in flux. For example, the EU General Data Protection Regulation ("GDPR") that became effective on May 25, 2018 imposes significant obligations on many U.S. companies, including us, to protect the personal information of European citizens. GDPR may be interpreted and applied in a manner that is inconsistent with our data practices such that our practices will be found to be non-compliant with this regulation. If so, this could result in government-imposed fines, orders or guidance requiring that we change our data practices, which could have a material adverse effect on our business. Complying with these various laws could cause us to incur substantial costs or require us to change our business practices in a manner adverse to our business. Certain state laws may also be more stringent or broader in scope, or offer greater individual rights, with respect to personal information than federal, international or other state laws, and such laws may differ from each other, all of which may complicate compliance efforts. New privacy rules are being enacted in the United States and globally, and existing ones are being updated and strengthened. For example, the California Consumer Privacy Act (the “CCPA”), which increases privacy rights for California residents and imposes obligations on companies that process their personal information, came into effect on January 1, 2020. Among other things, the CCPA requires covered companies to provide new disclosures to California consumers and provide such consumers new data protection and privacy rights, including the ability to opt-out of certain sales of personal information. The CCPA provides for civil penalties for violations, as well as a private right of action for certain data breaches that result in the loss of personal information. This private right of action may increase the likelihood of, and risks associated with, data breach litigation. The CCPA was amended in September 2018 and November 2019, and it is possible that further amendments will be enacted, but even in its current form it remains unclear how various provisions of the CCPA will be interpreted and enforced. State laws are changing rapidly and there is discussion in Congress of a new federal data protection and privacy law to which we would become subject if it is enacted. All of these evolving compliance and operational requirements impose significant costs that are likely to increase over time, may require us to modify our data processing practices and policies, divert resources from other initiatives and projects, and could restrict the way products and services involving data are offered, all of which may harm our business, financial condition and results of operations. Fluctuations in insurance costs and availability could adversely affect our profitability or our risk management profile. We hold a number of insurance policies, including product liability insurance, directors’ and officers’ liability insurance, general liability insurance, property insurance and workers’ compensation insurance. If the costs of maintaining adequate insurance coverage increase significantly in the future, our operating results could be materially adversely affected. Likewise, if any of our current insurance coverage should become unavailable to us or become economically impractical, we would be required to operate our business without coverage from commercial insurance providers. If we operate our business without insurance, we could be responsible for paying claims or judgments against us that would have otherwise been covered by insurance, which could adversely affect our results of operations or financial condition. Our ability to maintain our competitive position depends on our ability to attract and retain highly qualified personnel. We believe that our continued success depends to a significant extent upon our efforts and ability to retain highly qualified personnel. All of our officers and other employees are at-will employees, and therefore may terminate employment with us at any time with no advance notice. The replacement of any of our key personnel likely would involve significant time and costs and may significantly delay or prevent the achievement of our business objectives and would harm our business. Many of our employees have become or will soon become vested in a substantial amount of stock or number of stock options. Our employees may be more likely to leave the Company if the shares they own or the shares underlying their vested options have significantly appreciated in value relative to the original purchase prices of the shares or the exercise prices of the options, or if the exercise prices of the options that they hold are significantly below the market price of our common stock. Further, our employees’ ability to exercise those options and sell their stock in a public market may result in a higher than normal turnover rate. We do not carry any “key person” insurance policies. We may fail to perform certain services under the supply agreement with ReShape, and the performance of such services may negatively impact our business and operations. We have entered into a supply agreement with ReShape in connection with the sale of our Surgical product line to ReShape pursuant to which we agreed, among other things, to manufacture the Surgical products for ReShape until December 2020. If we do not satisfactorily perform our obligations under the supply agreement, we may be subject to liabilities to ReShape and our business may be adversely affected. We may be unable to collect future payments from ReShape related to the divestiture of our Surgical product line. 23 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. As part of the sale of the Surgical product line to ReShape, we are owed future payments of $2.0 million in December 2020 and $3.0 million in December 2021. Any failure of ReShape to timely pay some or all of the remaining future payments will adversely affect our business and financial position. If we fail to maintain an effective system of internal controls in the future, we may not be able to accurately or timely report our financial condition or results of operations, which may adversely affect investor confidence in us and, as a result, the value of our common stock. In connection with the audit of our consolidated financial statements for the year ended December 31, 2018, we identified a material weakness in our internal controls over financial reporting. The reported material weakness did not result in any adjustment to our financial statements or restatement of previously reported financial statements. A material weakness is a deficiency, or combination of deficiencies, in internal controls over financial reporting such that there is a reasonable possibility that a material misstatement of a company's annual or interim financial statements will not be prevented or detected on a timely basis. If our internal controls over financial reporting are found to be insufficient, our independent registered public accounting firm, which audits our financial statements, may issue an adverse opinion on the effectiveness of internal control over financial reporting. In the event that a material weakness is identified, we cannot assure you that we will be able to identify and implement measures that will be sufficient to remediate any such material weakness or that future material weaknesses will not occur. If we fail to remediate an identified material weakness or identify new material weaknesses in our internal controls over financial reporting, investors may lack confidence in the accuracy and completeness of our financial reports and the market price of our common stock could be negatively affected regardless of whether material inaccuracies are determined to exist in our reported financial statements. If material inaccuracies are determined to exist in our financial statements or we are unable to report our financial statements on a timely basis, we could also become subject to investigations by Nasdaq, the SEC, or other regulatory authorities, and become subject to litigation from investors and stockholders, which could harm our reputation and financial condition or divert financial and management resources from our regular business activities. The United Kingdom’s exit from the EU could lead to increased market access issues, legal issues, and economic conditions which could adversely impact our business. The U.K’s withdrawal from the EU is commonly referred to as “Brexit.” The U.K. and the EU have agreed to a withdrawal agreement (the “Withdrawal Agreement”) which was approved by the U.K. Parliament in January 2020. Under the Withdrawal Agreement, the U.K. will be subject to a transition period until December 31, 2020 (the “Transition Period”), during which EU rules will continue to apply. Negotiations between the U.K. and the EU are expected to continue to determine the customs and trading relationship that will exist between the U.K. and the EU following the expiration of the Transition Period. Our subsidiary that manages our European business is located in the U.K. and, thus, there are many ways in which our business operations may be impacted by Brexit, only some of which we can identify at this time. Our notified body in Europe was BSI based in the U.K., which will no longer have standing in the EU as a notified body. We subsequently transferred our notified body to BSI in the Netherlands which required that we change product labeling and packaging for all our products and may have other potential implications that have yet to be identified at this time. Financial markets could experience volatility which could negatively impact currency exchange rates and therefore the translated U.S. dollar value of our local currency sales to customers in the U.K. or Europe. We do not hedge our foreign currency transaction or translation risks. Our warehousing and distribution hub for Europe is in the Netherlands and distribution of our products in the U.K. market may be slowed or disrupted and our U.K. sales may suffer as a result. Our efforts to mitigate the risk of this supply disruption to our U.K. customers may not prove sufficient. If the U.K. and the EU are unable to negotiate acceptable trading and customs terms or if other EU member states pursue withdrawal, barrier-free access between the U.K. and other EU member states or among the European Economic Area overall could be diminished or eliminated. The long-term effects of Brexit will depend on any agreements (or lack thereof) between the U.K. and the EU and, in particular, any arrangements for the U.K. to retain access to EU markets after the Transition Period. Such a withdrawal from the EU is unprecedented, and it is unclear how the U.K.’s access to the European single market for goods, capital, services and labor within the EU, or single market, and the wider commercial, legal and regulatory environment, will impact our U.K. operations. There may continue to be economic uncertainty surrounding the consequences of Brexit which could negatively impact our financial condition, results of operations and cash flows. 24 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Risks Related to Regulatory Review and Approval of Our Products Our products are subject to extensive regulation by the FDA, including the requirement to obtain premarket approval and the requirement to report adverse events and violations of the U.S. Federal Food, Drug and Cosmetic Act that could present significant risk of injury to patients. Even though we have received FDA approval of our PMA applications and 510(k) clearances to commercially market our products, we will continue to be subject to extensive FDA regulatory oversight. Our products are subject to rigorous regulation by the FDA and numerous other federal, state and foreign governmental authorities. The process of obtaining regulatory clearances or approvals to market a medical device can be costly and time consuming, and we may not be able to obtain these clearances or approvals on a timely basis, if at all. In particular, the FDA permits commercial distribution of a new medical device only after the device has received clearance under Section 510(k) of the U.S. Federal Food, Drug and Cosmetic Act, or is the subject of an approved premarket approval application, or PMA unless the device is specifically exempt from those requirements. The FDA will clear marketing of a lower risk medical device through the 510(k) process if the manufacturer demonstrates that the new product is substantially equivalent to other pre-amendment, 510(k)-exempt, 510(k) cleared products, or PMA-approved products that have subsequently been down-classified. If the FDA determines that the device is not "substantially equivalent" to a predicate device, or if the device is automatically classified into Class III, the device sponsor must then fulfill the much more rigorous premarketing requirements of the PMA approval process, or seek reclassification of the device through the de novo process. Pursuant to amendments to the statute in 2012, a manufacturer can also submit a petition for a direct de novo review if the manufacturer is unable to identify an appropriate predicate device and the new device or new use of the device presents a moderate or low risk. High risk devices deemed to pose the greatest risk, such as life-sustaining, life-supporting, or implantable devices, or devices not deemed substantially equivalent to a previously cleared device, require the approval of a PMA. In addition, the FDA may deem certain uses of an existing cleared general use device, such as OverStitch, to be a high risk use and may require the submission of a PMA prior to expanding the device's indication for such additional use. The PMA process is more costly, lengthy and uncertain than the 510(k) clearance process. A PMA application must be supported by extensive data, including, but not limited to, technical, preclinical, clinical trial, manufacturing and labeling data, to demonstrate to the FDA’s satisfaction the safety and efficacy of the device for its intended use. Of our products, Orbera is a class III product and has been approved through the FDA's PMA process and our OverStitch products are class II products and have been cleared through the 510(k) process. In addition, although FDA has granted PMA approval for our class III products, holding those approvals in good standing requires ongoing compliance with FDA reporting requirements and conditions of approval including the completion of lengthy and expensive post market approval studies. Despite the time, effort and cost required to obtain approval, there can be no assurance that we will be able to meet all FDA requirements to maintain our PMA approvals or that circumstances outside of our control may cause the FDA to withdraw our PMA approvals. Our failure to comply with U.S. federal, state and foreign governmental regulations could lead to the issuance of warning letters or untitled letters, the imposition of injunctions, suspensions or loss of regulatory clearance or approvals, product recalls, termination of distribution, product seizures or civil penalties. In the most extreme cases, criminal sanctions or closure of our manufacturing facility are possible. If we fail to comply with U.S. federal and state healthcare fraud and abuse or data privacy and security laws and regulations, we could be subject to penalties, including, but not limited to, administrative, civil and criminal penalties, damages, fines, disgorgement, exclusion from participation in governmental healthcare programs and the curtailment of our operations, any of which could adversely impact our reputation and business operations. Our industry is subject to numerous U.S. federal and state healthcare laws and regulations, including, but not limited to, anti-kickback, false claims, privacy and transparency laws and regulations. Our relationships with healthcare providers and entities, including but not limited to, physicians, hospitals, ambulatory surgery centers, group purchasing organizations and our international distributors are subject to scrutiny under these laws. Violations of these laws or regulations can subject us to penalties, including, but not limited to, administrative, civil and criminal penalties, damages, fines, disgorgement, imprisonment, exclusion from participation in federal and state healthcare programs, including the Medicare, Medicaid and Veterans Administration health programs and the curtailment of our operations. Healthcare fraud and abuse regulations are complex and subject to evolving interpretations and enforcement discretion, and even minor irregularities can potentially give rise to claims that a statute or regulation has been violated. The laws that may affect our ability to operate include, but are not limited to: • the federal Anti-Kickback Statute, which prohibits, among other things, persons and entities from knowingly and willfully soliciting, receiving, offering or paying remuneration, directly or indirectly, in cash or in kind, in exchange for or to induce either the referral of an individual for, or the purchase, lease, order or recommendation of, any good, facility, item or service for which payment may be made, in whole or in part, under federal healthcare programs such as Medicare and Medicaid; the FCA, which prohibits, among other 25 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. things, individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid or other third- party payors that are false or fraudulent; knowingly making using, or causing to be made or used, a false record or statement to get a false or fraudulent claim paid or approved by the government; or knowingly making, using, or causing to be made or used, a false record or statement to avoid, decrease or conceal an obligation to pay money to the federal government; the civil monetary penalties statute, which imposes penalties against any person or entity who, among other things, is determined to have presented or caused to be presented, a claim to a federal healthcare program that the person knows, or should know, is for an item or service that was not provided as claimed or is false or fraudulent; the federal Health Insurance Portability and Accountability Act of 1996, and the federal Health Information Technology for Economic and Clinical Health Act of 2009, each as amended, and their implementing regulations, which impose requirements upon certain entities relating to the privacy, security, and transmission of health information; the Federal Trade Commission Act and similar laws regulating advertisement and consumer protections; the federal Foreign Corrupt Practices Act, which prohibits corrupt payments, gifts or transfers of value to foreign officials; and foreign or U.S. state law equivalents of each of the above federal laws • • • • • While we do not submit claims for reimbursement to payors and our customers make the ultimate decision on how to submit claims, from time-to-time, we may be asked for reimbursement guidance by our customers. Failure to comply with any of these laws, or any action against us for alleged violation of these laws, even if we successfully defend against it, could result in a material adverse effect on our reputation, business, results of operations and financial condition. We have entered into consulting agreements with physicians, including some who use our products and may influence the ordering and use of our products. While we believe these transactions were structured to comply with all applicable laws, including state and federal anti-kickback laws, to the extent applicable, should the government take the position that these transactions are prohibited arrangements that must be restructured or discontinued, we could be subject to significant penalties. The medical device industry’s relationship with physicians is under increasing scrutiny by the OIG, the DOJ, state attorneys general, and other foreign and domestic government agencies. Our failure to comply with laws, rules and regulations governing our relationships with physicians, or an investigation into our compliance by the OIG, DOJ, state attorneys general and other government agencies could significantly harm our business. To enforce compliance with the healthcare regulatory laws, federal and state enforcement bodies have recently increased their scrutiny of interactions between healthcare companies and healthcare providers, which has led to a number of investigations, prosecutions, convictions and settlements in the healthcare industry. Responding to investigations can be time and resource consuming and can divert management’s attention from the business. Additionally, as a result of these investigations, healthcare providers and entities may have to agree to onerous additional compliance and reporting requirements as part of a consent decree or corporate integrity agreement. Any such investigation or settlement could increase our costs or otherwise have an adverse effect on our business. In addition, there has been a recent trend of increased federal and state regulation of payments and transfers of value provided to healthcare professionals or entities. The Affordable Care Act’s provision commonly referred to as the federal Physician Payment Sunshine Act, as well as similar state and foreign laws, impose obligations on medical device manufacturers to annually report certain payments and other transfers of value provided, directly or indirectly, to certain physicians and teaching hospitals, as well as ownership and investment interests held by physicians and their family members. Failure to comply with any of these state, federal, or foreign transparency and disclosure requirements could subject us to significant fines and penalties. The shifting commercial compliance environment and the need to build and maintain robust and expandable systems to comply with different compliance and reporting requirements in multiple jurisdictions increase the possibility that we may fail to comply fully with one or more of these requirements. Although compliance programs can mitigate the risk of investigation and prosecution for violations of these laws, the risks cannot be entirely eliminated. Any action against us for violation of these laws, even if we successfully defend against it, could cause us to incur significant legal expenses and divert our management’s attention from the operation of our business. Most of these laws apply to not only the actions taken by us, but also actions taken by our distributors. We have limited knowledge and control over the business practices of our distributors, and we may face regulatory action against us as a result 26 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. of their actions which could have a material adverse effect on our reputation, business, results of operations and financial condition. In addition, the scope and enforcement of these laws is uncertain and subject to rapid change in the current environment of healthcare reform, especially in light of the lack of applicable precedent and regulations. Federal or state regulatory authorities might challenge our current or future activities under these laws. Any such challenge could have a material adverse effect on our reputation, business, results of operations and financial condition. Any state or federal regulatory review of the Company, regardless of the outcome, would be costly and time-consuming. Additionally, we cannot predict the impact of any changes in these laws, whether or not retroactive. Healthcare cost containment pressures and legislative or administrative reforms resulting in restrictive reimbursement practices of third-party payors could decrease the demand for our products, the prices that customers are willing to pay and the number of procedures performed using our products, which could have an adverse effect on our business. All third-party payors, whether governmental or commercial, whether inside the U.S. or outside, are developing increasingly sophisticated methods of controlling healthcare costs. These cost-control methods include prospective payment systems, bundled payment models, capitated arrangements, group purchasing, benefit redesign, pre-authorization processes and requirements for second opinions prior to major surgery. These cost-control methods also potentially limit the amount that healthcare providers may be willing to pay for our products. Therefore, coverage or reimbursement for medical devices may decrease in the future. Federal and state governments in the U.S. and outside the U.S. may enact legislation to modify the healthcare system which may result in increased government price controls, additional regulatory mandates and other measures designed to constrain medical costs. These reform measures may limit the amounts that federal and state governments will pay for healthcare products and services, and also indirectly affect the amounts that private payors are willing to pay. These changes could result in reduced demand for our products and may adversely affect our operating results. Further, from time to time, typically on an annual basis, payment amounts are updated and revised by third-party payors. In cases where the cost of certain of our products are recovered by the healthcare provider as part of the payment for performing a procedure and not separately reimbursed or paid directly by the patient, these updates could directly impact the demand for our products. We cannot predict how pending and future healthcare legislation will impact our business, and any changes in coverage and reimbursement that further restricts coverage of our products or lowers reimbursement for procedures using our products could materially affect our business. Modifications to our marketed products may require new 510(k) or de novo clearances or PMA approvals, or may require us to cease marketing or recall the modified products until clearances or approvals are obtained. Modifications to our products may require new regulatory approvals or clearances, including 510(k) or de novo clearances or premarket approvals, or require us to recall or cease marketing the modified devices until these clearances or approvals are obtained. The FDA and other regulatory authorities outside the United States require device manufacturers to initially make and document a determination of whether or not a modification requires a new approval, supplement or clearance. For example, a manufacturer may determine that a modification does not significantly affect safety or efficacy and does not represent a major change in its intended use, so that no new 510(k) clearance is necessary. However, a given regulatory authority, such as the FDA, can review a manufacturer's decision and may disagree and on its own initiative determine that a new clearance or approval is required. We have made modifications to our products in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. If a regulatory authority disagrees and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing our products as modified, which could require us to redesign our products, re-introduce pre-modified product back into the specific market, and harm our operating results. In addition, a regulatory authority in one country may not agree with the conclusion of a regulatory authority of another country. In these circumstances, we may be subject to significant enforcement actions. If we determine that a modification to an FDA-cleared device could significantly affect its safety or efficacy, or would constitute a major change in its intended use, then we must file for a new 510(k) clearance or possibly de novo, down classification, or a premarket approval application. Where we determine that modifications to our products require a new 510(k) or de novo clearance or premarket approval application, we may not be able to obtain those additional clearances or approvals for the modifications or additional indications in a timely manner, or at all. For those products sold in the EU, we must notify our EU Notified Body, if significant changes are made to the products or if there are substantial changes to our quality assurance systems affecting those products. Obtaining clearances and approvals can be a time consuming process, and delays in obtaining required future clearances or approvals would adversely affect our ability to introduce new or enhanced products in a timely manner, which in turn would harm our sales. 27 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. For our class III devices, new PMAs or PMA supplements are required for modifications that affect the safety or effectiveness of the device, including, for example, certain types of modifications to the device's indication for use, manufacturing process, labeling and design. PMA supplements often require submission of the same type of information as a PMA, except that the supplement is limited to information needed to support any changes to the device covered by the original PMA and may not require as extensive clinical data or the convening of an advisory panel. There is no guarantee that the FDA will grant PMA approval of our future products and failure to obtain necessary approvals for our future products would adversely affect our ability to grow our business. Delays in receipt or failure to receive approvals, the loss of previously received approvals, or the failure to comply with existing or future regulatory requirements could reduce our sales, profitability and future growth prospects. Expanding the indications of our marketed products may require new 510(k) or de novo clearances or PMA approvals. Expanding the indications for our products will require new regulatory approvals or clearances, including 510(k) or de novo clearances or PMA approvals. We have current products such as OverStitch with clearance as a general use device but no procedure-specific indications for use. In the event that we pursue the approval of expanded indications for a product, the FDA may require a separate 510(k) or de novo submission or may deem the desired indication for use to be of high enough risk to require a PMA submission. For example, the investigators conducting the MERIT trial sought and received an Investigational Device Exemption following communication from the FDA which indicated that the FDA considered the ESG procedure for weight loss to be a high risk use. Obtaining clearances and approvals for expanded uses can be a time consuming and costly process and could adversely affect our ability to market our products or delay efforts to obtain reimbursement coverage from payors. If our products contribute to a death or a serious injury, or malfunction in certain ways, we will be subject to medical device reporting regulations, which can result in voluntary corrective actions or agency enforcement actions. Under the FDA medical device reporting regulations, medical device manufacturers are required to report to the FDA information that a device has or may have caused or contributed to a death or serious injury or has malfunctioned in a way that would likely cause or contribute to death or serious injury if the malfunction of the device were to recur. As required per the FDA Code of Federal Regulations (21 CFR) Part 803, we have established procedures and processes for documentation and evaluation of all complaints relative to reporting requirements. As with all device manufacturers, we have 30 days from "becoming aware" of an incident to submit to FDA a MDR for an event that reasonably suggests that a device has or may have caused or contributed to the incident, or five work days for an event designated by the FDA or an event that requires remedial action to prevent an unreasonable risk of substantial harm to the public health. As part of this assessment we conduct a complaint investigation of each reported Adverse Event. In the event that an investigation is inconclusive (i.e., the investigation cannot confirm whether or not our product was a cause of an Adverse Event), our policy and practice is to default in favor of reporting events to the FDA. If we fail to report these events to the FDA within the required timeframes, or at all, FDA could take enforcement action against us. Any such adverse event involving our products or for which we cannot confirm whether or not our product caused or contributed to the adverse event also could result in future voluntary corrective actions, such as recalls or customer notifications, or agency action, such as inspection or enforcement action. Any corrective action, whether voluntary or involuntary, as well as defending ourselves in a lawsuit, will require the dedication of our time and capital, distract management from operating our business, and may harm our reputation and financial results. The FDA may issue safety alerts in response to its review of reported Adverse Events that do not require voluntary corrective actions or agency enforcement but that still negatively affect our product marketing efforts. For instance, in February of 2017, the FDA issued an update to alert health care providers of reported adverse events of liquid-filled intragastric balloons including several dozen incidents of balloon over-inflation and, separately, a set of reports of acute pancreatitis. In August of 2017, the FDA issued a second update to alert health care providers of five reports of unanticipated deaths that had been reported since 2016 in patients with liquid-filled intragastric balloons, four of which had received our IGB. In June 2018, the FDA issued a new update to alert health care providers of five additional reports worldwide of unanticipated deaths that had been reported since the August 2017 letter to Health Care Providers and also announced the approval of labeling changes for the Orbera Balloon System. Four of the additional mentioned reported deaths involved patients who had received our IGB product. In each case, the occurrence had been self-reported by us to the FDA as part of our normal product surveillance process. Neither the FDA's August 2017 letter to Health Care Providers nor the June 2018 letter to Health Care Providers indicates that the patient deaths were related to the intragastric balloon product or the insertion procedures. However, both letters to Health Care Providers subjected us to adverse publicity that harmed our business. Our international operations must comply with local laws and regulations that present certain legal and operating risks, which could adversely impact our business, results of operations and financial condition. We currently operate in the U.S., Canada, Brazil, Costa Rica, Australia and various European countries and our products are approved for sale in over 75 different countries; our activities are subject to U.S. and foreign governmental trade, import 28 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. and export and customs regulations and laws. Compliance with these regulations and laws is costly and exposes us to penalties for non-compliance. Other laws and regulations that can significantly impact us include various anti-bribery laws, including the U.S. FCPA, as well as export control laws and economic sanctions laws. Any failure to comply with applicable legal and regulatory obligations could impact us in a variety of ways that include, but are not limited to, significant costs and disruption of business associated with an internal and/or government investigation, criminal, civil and administrative penalties, including imprisonment of individuals, fines and penalties, denial of export privileges, seizure of shipments, restrictions on certain business activities and exclusion or debarment from government contracting. Our international operations present the same risks as presented by our U.S. operations plus unique risks inherent in operating in foreign jurisdictions. These unique risks include: • • • • • • • • • • • foreign regulatory approval which could result in delays leading to possible insufficient inventory levels; foreign currency exchange rate fluctuations; reliance on sales people and distributors; pricing pressure that we may experience internationally; competitive disadvantage to competitors who have more established business and customer relationships in a given market; reduced or varied intellectual property rights available in some countries; economic instability of certain countries; the imposition of additional U.S. and foreign governmental controls, regulations and laws; changes in duties and tariffs, license obligations, importation requirements and other non-tariff barriers to trade; scrutiny of foreign tax authorities which could result in significant fines, penalties and additional taxes being imposed on the Company; and laws and business practices favoring local companies. If we experience any of these events, our business, results of operations and financial condition may be harmed. If we or our suppliers fail to comply with ongoing FDA or foreign regulatory authority requirements, or if we experience unanticipated problems with our products, these products could be subject to restrictions or withdrawal from the market. Any product for which we obtain approval or clearance, and the manufacturing processes, reporting requirements, post-market clinical data and promotional activities for such product, will be subject to continued regulatory review, oversight and periodic inspections by the FDA and other domestic and foreign regulatory bodies. In particular, we and our third-party suppliers are required to comply with the QSR. The QSR covers the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our products. Compliance with applicable regulatory requirements is subject to continual review and is monitored rigorously through periodic inspections by the FDA. If we, or our manufacturers, fail to adhere to QSR requirements in the U.S. or experience delays in obtaining necessary regulatory approvals or clearances, this could delay production of our products and lead to fines, difficulties in obtaining regulatory approvals or clearances, recalls, enforcement actions, including injunctive relief or consent decrees, or other consequences, which could, in turn, have a material adverse effect on our financial condition or results of operations. In addition, the FDA audits compliance with the QSR through periodic announced and unannounced inspections of manufacturing and other facilities. The failure by the Company or one of our suppliers to comply with applicable statutes and regulations administered by the FDA, or the failure to timely and adequately respond to any adverse inspection observations or product safety issues, could result in any of the following enforcement actions: • • • • untitled letters, warning letters, fines, injunctions, consent decrees and civil penalties; unanticipated expenditures to address or defend such actions; customer notifications or repair, replacement, refunds, recall, detention or seizure of our products; operating restrictions, partial suspension or total shutdown of production; 29 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. • • • • refusing or delaying our requests for regulatory approvals or clearances of new products or modified products; withdrawing PMA approvals that have already been granted; refusal to grant export approval for our products; or criminal prosecution. Any of these sanctions could have a material adverse effect on our reputation, business, results of operations and financial condition. Furthermore, our key component suppliers may not currently be or may not continue to be in compliance with all applicable regulatory requirements, which could result in a failure to produce our products on a timely basis and in the required quantities, if at all. Our products and operations are required to comply with standards set by foreign regulatory bodies, and those standards, types of evaluation and scope of review differ among foreign regulatory bodies. If we fail to comply with any of these standards adequately or if changes to our manufacturing or supply practices require additional regulatory approval, a foreign regulatory body may take adverse actions or cause delays within their jurisdiction similar to those within the power of the FDA. Any such action or circumstance may harm our reputation and business, and could have an adverse effect on our business, results of operations and financial condition. Our products may in the future be subject to product recalls that could harm our reputation, business and financial results. We may, under our own initiative, recall a product if any material deficiency in a device is found. In addition, the FDA and similar foreign governmental authorities can require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture. In the case of the FDA, the recall must be based on an FDA finding that there is a reasonable probability that the device would cause serious injury or death. In addition, foreign governmental bodies have the authority to require the recall of our products in the event of material deficiencies or defects in design or manufacture. A government-mandated or voluntary recall by us or one of our distributors could occur as a result of component failures, manufacturing errors, design or labeling defects or other deficiencies and issues. Recalls of any of our products would divert managerial and financial resources and have an adverse effect on our financial condition and results of operations. The FDA requires that certain classifications of voluntary recalls be reported to FDA within 10 working days after the recall is initiated. Companies are required to maintain certain records of recalls, even if they are not reportable to the FDA. We may initiate voluntary recalls involving our products in the future that we determine do not require notification of the FDA. If the FDA disagrees with our determinations, they could require us to report those actions as recalls. A future recall announcement could harm our reputation with customers and negatively affect our sales. In addition, the FDA could take enforcement action for failing to report the recalls when they were conducted. U.S. legislative, FDA or global regulatory reforms may make it more difficult and costly for us to obtain regulatory approval of our product candidates and to manufacture, market and distribute our products after approval is obtained. From time to time, legislation is drafted and introduced in Congress that could significantly change the statutory provisions governing the regulatory approval, manufacture and marketing of regulated products or the reimbursement thereof. Any new regulations or revisions or reinterpretations of existing regulations may impose additional costs or lengthen review times of future products. In addition, FDA regulations and guidance are often revised or reinterpreted by the agency in ways that may significantly affect our business and our products. It is impossible to predict whether legislative changes will be enacted or FDA regulations, guidance or interpretations changed, and what the impact of such changes, if any, may be. Moreover, organizational changes within the FDA as well as recent and future federal election outcomes could result in significant legislative and regulatory reforms impacting the FDA’s regulation of our products. Any change in the laws or regulations that govern the clearance and approval processes relating to our current and future products could make it more difficult and costly to obtain clearance or approval for new products, or to produce, market and distribute existing products. Significant delays in receiving clearance or approval, or the failure to receive clearance or approval for our new products would have an adverse effect on our ability to expand our business. In addition, on May 25, 2017, the new EU Medical Devices Regulation ("MDR 2017") was published and will become effective on May 26, 2020. The MDR 2017 changes certain obligations of medical device manufacturers with product in the EU and will subject high risk medical devices to additional scrutiny during the conformity assessment process. MDR 2017 repeals and replaces the EU Medical Devices Directive and intends to eliminate current differences in the regulation of medical devices among EEA Member States. The new regulations will among other things: • add new rules on placing devices on the market and reinforce surveillance once they are available; 30 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. • • • • establish explicit provisions on manufacturers' responsibilities for the follow-up of the quality, performance and safety of devices placed on the market; require the traceability of medical devices throughout the supply chain to the end-user or patient through a unique identification number; set up a central database to provide patients, healthcare professionals and the public with comprehensive information on products available in the EU; and add rules for the assessment of certain high-risk devices which may have to undergo an additional check by experts before they are placed on the market; • modify or increase clinical evidence requirements necessary to maintain existing CE marks In addition, the MDR 2017 may impose increased compliance obligations for us to access the EU market. In order to continue to sell our products in Europe, we must maintain our CE marks and continue to comply with certain EU directives and, in the future with the MDR 2017. Our failure to continue to comply with applicable foreign regulatory requirements, including meeting additional clinical evidence requirements and complying with regulatory requirements administered by authorities of the EEA countries, could result in enforcement actions against us, including refusal, suspension or withdrawal of our CE Certificates of Conformity by our Notified Body, which could impair our ability to market products in the EEA in the future. Any changes to the membership of the EU, such as the departure of the United Kingdom (Brexit), may impact the regulatory requirements for the impacted countries and impair our business operations and our ability to market products in such countries. We are also subject to regulations and periodic review from various regulatory bodies in other countries where our products are sold. Lack of regulatory compliance in any of these jurisdictions could limit our ability to distribute products in these countries. In many of these circumstances, we rely significantly on independent distributors to comply with the varying regulations, and any failures on their part could result in restrictions on the sale of our products. If the third parties on which we rely to conduct our clinical trials and to assist us with post market studies do not perform as contractually required or expected, we may not be able to maintain regulatory approval for our products. We often must rely on third parties, such as medical institutions, clinical investigators, contract research organizations and contract laboratories to conduct our clinical trials and provide data or prepare deliverables for our PMA post market studies or CE Mark post-approval studies required to keep our market approvals in good standing. If these third parties do not successfully carry out their contractual duties or regulatory obligations or meet expected deadlines, if these third parties need to be replaced, or if the quality or accuracy of the data they obtain is compromised due to the failure to adhere to applicable clinical protocols or regulatory requirements or for other reasons, our clinical activities or clinical trials may be extended, delayed, suspended or terminated, and we may be at risk of losing our regulatory approvals, or fail to obtain desired regulatory approvals, which could harm our business. Our operations involve the use of hazardous and toxic materials, and we must comply with environmental laws and regulations, which can be expensive, and may affect our business and operating results. We are subject to a variety of federal, state and local regulations relating to the use, handling, storage, disposal and human exposure to hazardous materials. Liability under environmental laws can be joint and several and without regard to comparative fault, and environmental laws could become more stringent over time, imposing greater compliance costs and increasing risks and penalties associated with violations, which could harm our business. Although we believe that our activities conform in all material respects with environmental laws, there can be no assurance that violations of environmental and health and safety laws will not occur in the future as a result of human error, accident, equipment failure or other causes. The failure to comply with past, present or future laws could result in the imposition of fines, third-party property damage and personal injury claims, investigation and remediation costs, the suspension of production or a cessation of operations. We also expect that our operations may be affected by other new environmental and health and safety laws on an ongoing basis. Although we cannot predict the ultimate impact of any such new laws, they will likely result in additional costs, and may require us to change how we manufacture our products, which could have a material adverse effect on our business. Failure to comply with the U.S. FCPA and similar laws associated with any activities outside the U.S. could subject us to penalties and other adverse consequences. We are subject to the U.S. FCPA, and other anti-bribery legislation around the world. The FCPA generally prohibits covered entities and their intermediaries from engaging in bribery or making other prohibited payments, offers or promises to foreign officials for the purpose of obtaining or retaining business or other advantages. In addition, the FCPA imposes 31 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. recordkeeping and internal controls requirements on publicly traded corporations and their foreign affiliates. We may face significant risks if we fail to comply with the FCPA and other similar foreign antibribery laws. Although we have implemented safeguards and training, including company policies requiring our employees, distributors, consultants and agents to comply with the FCPA and similar laws, our international operations nonetheless present a risk of unauthorized payments or offers of payments by one of our employees, consultants, sales agents, or distributors, because these parties are not always subject to our control. Any violation of the FCPA and related policies could result in severe criminal or civil sanctions, which could have a material and adverse effect on our reputation, business, operating results and financial condition. Risks Related to Our Intellectual Property Intellectual property rights may not provide adequate protection, which may permit third parties to compete against us more effectively. Our success depends significantly on our ability to protect our proprietary rights to the technologies and inventions used in, or embodied by, our products. To protect our proprietary technology, we rely on patent protection, as well as a combination of copyright, trade secret and trademark laws, as well as nondisclosure, confidentiality and other contractual restrictions in our supply, consulting and employment agreements. However, these legal means afford only limited protection and may not adequately protect our rights or permit us to gain or keep any competitive advantage. Patents The process of applying for patent protection itself is time consuming and expensive and we cannot assure investors that all of our patent applications will issue as patents or that, if issued, they will issue in a form that will be advantageous to us. The rights granted to us under our patents, including prospective rights sought in our pending patent applications, may not be meaningful or provide us with any commercial advantage and they could be opposed, contested or circumvented by our competitors or be declared invalid or unenforceable in judicial or administrative proceedings. We own numerous issued patents and pending patent applications that relate to our products and methods of using our products, as well as individual components of our products. If any of our patents are challenged, invalidated or legally circumvented by third parties, and if we do not own other enforceable patents protecting our products, competitors could market products and use processes that are substantially similar to, or superior to, ours, and our business will suffer. In addition, the patents we own may not be sufficient in scope or strength to provide us with any meaningful protection or commercial advantage, and competitors may be able to design around our patents or develop products that provide outcomes comparable to ours without infringing on our intellectual property rights. We may also determine from time to time to discontinue the payment of maintenance fees, if we determine that certain patents are not material to our business. We may be subject to a third-party preissuance submission of prior art to the U.S. Patent and Trademark Office ("USPTO"), or become involved in opposition, derivation, reexamination, inter partes review, post-grant review, or other patent office proceedings or litigation, in the U.S. or elsewhere, challenging our patent rights or the patent rights of others. An adverse determination in any such submission, proceeding or litigation could reduce the scope of, or invalidate, our patent rights, allow third parties to commercialize our technology or products and compete directly with us, without payment to the Company, or result in our inability to manufacture or commercialize products without infringing third-party patent rights. Moreover, the USPTO and various foreign governmental patent agencies require compliance with a number of procedural, documentary, fee payment and other similar provisions during the patent application process. In addition, periodic maintenance fees on issued patents often must be paid to the USPTO and foreign patent agencies over the lifetime of the patent. While an unintentional lapse can in many cases be cured by payment of a late fee or by other means in accordance with the applicable rules, there are situations in which noncompliance can result in abandonment or lapse of the patent or patent application, resulting in partial or complete loss of patent rights in the relevant jurisdiction. Non-compliance events that could result in abandonment or lapse of a patent or patent application include, but are not limited to, failure to respond to official actions within prescribed time limits, non-payment of fees and failure to properly legalize and submit formal documents. If we fail to maintain the patents and patent applications covering our products or procedures, we may not be able to stop a competitor from marketing products that are the same as or similar to our products, which would have a material adverse effect on our business. Furthermore, we do not have patent rights in certain foreign countries in which a market may exist in the future, and the laws of many foreign countries may not protect our intellectual property rights to the same extent as the laws of the U.S. Thus, we may not be able to stop a competitor from marketing and selling in foreign countries products that are the same as or similar to our products. 32 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Trademarks We rely on our trademarks as one means to distinguish our products from the products of our competitors and have registered or applied to register many of these trademarks. Our trademark applications may not be approved, however. Third parties may oppose our trademark applications, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing new brands. Our competitors may infringe our trademarks and we may not have adequate resources to enforce our trademarks. Trade Secrets and Know-How We may not be able to prevent the unauthorized disclosure or use of our technical knowledge or other trade secrets by consultants, vendors, former employees or current employees, despite the existence of confidentiality agreements and other contractual restrictions. Monitoring unauthorized uses and disclosures of our intellectual property is difficult, and we do not know whether the steps we have taken to protect our intellectual property will be effective. Moreover, our competitors may independently develop equivalent knowledge, methods and know-how. Competitors could purchase our products and attempt to replicate some or all of the competitive advantages we derive from our development efforts, willfully infringe our intellectual property rights, design around our protected technology or develop their own competitive technologies that fall outside of our intellectual property rights. If our intellectual property is not adequately protected so as to protect our market against competitors’ products and methods, our competitive position could be adversely affected, as could our business. We may in the future be a party to patent and other intellectual property litigation and administrative proceedings that could be costly and could interfere with our ability to sell our products. The medical device industry has been characterized by frequent and extensive intellectual property litigation. Additionally, the bariatric and therapeutic endoscopy markets are competitive. Our competitors or other patent holders may assert that our products and the methods we employ are covered by their patents. If our products or methods are found to infringe, we could be prevented from manufacturing or marketing our products. In the event that we become involved in such a dispute, we may incur significant costs and expenses and may need to devote resources to resolving any claims, which would reduce the cash we have available for operations and may be distracting to management. We do not know whether our competitors or potential competitors have applied for, will apply for, or will obtain patents that will prevent, limit or interfere with our ability to make, use, sell, import or export our products. Competing products may also be sold in other countries in which our patent coverage might not exist or be as strong. If we lose a foreign patent lawsuit, alleging our infringement of a competitor’s patents, we could be prevented from marketing our products in one or more foreign countries. We may also initiate litigation against third parties to protect our own intellectual property. Our intellectual property has not been tested in prior litigation. If we initiate litigation to protect our rights, we run the risk of having our intellectual property rights adjudicated, invalidated, or limited in scope, which would undermine our competitive position. Litigation related to infringement and other intellectual property claims, with or without merit, is unpredictable, expensive and time-consuming and can divert management’s attention from our core business. If we lose this kind of litigation, a court could require us to pay substantial damages, treble damages and attorneys’ fees, and prohibit us from using technologies essential to our products, any of which would have a material adverse effect on our business, results of operations and financial condition. If relevant patents held by other parties are upheld as valid and enforceable and we are found to infringe, we could be prevented from selling our products unless we can obtain licenses to use technology or ideas covered by such patents. We do not know whether any necessary licenses would be available to us on satisfactory terms, if at all. If we cannot obtain these licenses, we could be forced to design around those patents at additional cost or abandon our products altogether. As a result, our ability to grow our business and compete in the market may be harmed. We may be subject to damages resulting from claims that we or our employees have wrongfully used or disclosed alleged trade secrets of our competitors or are in breach of non-competition or non-solicitation agreements with our competitors. Many of our employees were previously employed at other medical device companies, including our competitors or potential competitors. We could in the future be subject to claims that we or our employees have inadvertently or otherwise used or disclosed alleged trade secrets or other proprietary information of these former employers or competitors. In addition, we may in the future be subject to claims that we caused an employee to breach the terms of his or her non- competition or non-solicitation agreement and litigation may be necessary to defend against these claims. Even if we are successful in defending against these claims, litigation could result in substantial costs and could be a distraction to management. If our defense to those claims fails, in addition to paying monetary damages, a court could prohibit us from using technologies or features that are 33 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. essential to our products or information that is essential to our business operations, if such technologies, features or information are found to incorporate or be derived from the trade secrets or other proprietary information of the former employers. An inability to incorporate technologies, features or information that are important or essential to our products or business operations would have a material adverse effect on our business and may prevent us from selling our products. In addition, we may lose valuable intellectual property rights or personnel. Any litigation or the threat thereof may adversely affect our ability to hire employees. A loss of key personnel or their work product could hamper or prevent our ability to commercialize our products and conduct business, which could have an adverse effect on our business, results of operations and financial condition. Risks Related to Our Capital Requirements and Finances The auditor's opinion on our audited financial statements for the fiscal year ended December 31, 2019, included in this annual report on Form 10-K, contains an explanatory paragraph relating to our ability to continue as a going concern. The auditor's opinion on our audited financial statements for the year ended December 31, 2019 includes an explanatory paragraph stating that our losses and negative cash flows from operations and uncertainty in generating sufficient cash to meet our operations raise substantial doubt about our ability to continue as a going concern. While we are pursuing a variety of funding sources and transactions that could raise capital, there can be no assurances that we will be successful in these efforts or will be able to resolve our liquidity issues or eliminate our operating losses. If we are unable to obtain sufficient funding, we would need to significantly reduce our operating plans and curtail some or all of our product development, commercialization and strategic plans. Accordingly, our business, prospects, financial condition and results of operations will be materially and adversely affected, and we may be unable to continue as a going concern. If we are unable to continue as a going concern, we may have to liquidate our assets and may receive less than the value at which those assets are carried on our audited consolidated financial statements, and it is likely that investors will lose all or a part of their investment. If we seek additional financing to fund our business activities in the future and there remains substantial doubt about our ability to continue as a going concern, investors or other financing sources may be unwilling to provide additional funding on commercially reasonable terms or at all. We have substantial indebtedness which contain restrictive covenants that may limit our operating flexibility and our failure to comply with the covenants and payment requirements of our indebtedness may subject us to increased interest expenses, lender consent and amendment costs or adverse financial consequences. In March 2019, we borrowed $35.0 million principal amount of debt under a term loan facility ("Solar Debt Facility") with Solar Capital, Ltd. ("Solar"). In March 2020, we entered into an amendment to this agreement that provides an additional $10 million of funding in July 2020 if certain revenue milestones are achieved through June 2020. We may borrow an additional $5.0 million upon our request subject to further credit approval. We cannot assure you that additional funding will be received. We used $22.4 million of the proceeds to repay the existing senior secured credit facility. Our outstanding debt is collateralized by substantially all of our assets and contains customary financial and operating covenants limiting our ability to transfer or dispose of assets, merge with or acquire other companies, make investments, pay dividends, incur additional indebtedness and liens and conduct transactions with affiliates without Solar's consent. We therefore may not be able to engage in any of the foregoing transactions until our current debt obligations are paid in full or we obtain the consent of the lender. In addition, we are required to prepare our financial statements and receive audits on our annual financial statements in a timely manner, meet certain financial ratio requirements and pay interest and principal when due. Furthermore, under the Solar Debt Facility our interest rate is tied to LIBOR. We do not hedge this variable rate exposure to LIBOR and in the event of an increase in the LIBOR rate, we will be required to pay greater interest expenses, which may be material and have an adverse effect on our net loss and financial condition. To the extent that our operating trends do not enable us to meet our financial and restrictive covenant requirements, we are unable to pay interest or principal when due or we are unable to meet other covenants and requirements contained within our credit agreements, we may default under such agreement. A default under any such agreements could result in further increases in consent or amendment fees to our lender, further increases in interest costs, the imposition of additional constraints on borrowing by our lender or potentially more serious liquidity constraints and adverse financial consequences, including reductions in the value of our common stock or the necessity of seeking protection from creditors under bankruptcy laws. To remedy issues we may encounter with meeting our debt obligations, or for other purposes, we may find it necessary to seek further refinancing of our indebtedness, and may do so with debt instruments that are more costly than our existing instruments (and which will rank senior to our common shareholders), or we may issue additional securities which may dilute the ownership interests or value of our existing shareholders. We cannot assure you that we will be able to generate sufficient cash flows or revenue to meet the financial covenants or pay the principal and interest on our debt. Furthermore, we cannot assure you that future working capital, borrowings or equity financing will be available to repay or refinance any such debt. 34 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. We may need substantial additional funding and may be unable to raise capital when needed, which would force us to delay, reduce, eliminate or abandon our commercialization efforts or product development programs. We may need to raise substantial additional capital to fund our operations, including: • • • • • • • • expand the commercialization of our products; fund our operations and clinical studies; continue our research and development activities; support and expand ongoing manufacturing activities; defend or enforce, in litigation or otherwise, our patent and other intellectual property rights and any claims that we infringe on third-party patents or other intellectual property rights; address legal or enforcement actions by the FDA or other governmental agencies and remediate underlying problems; commercialize our new products in development, if any such products receive regulatory clearance or approval for commercial sale; and acquire companies or products and in-license products or intellectual property. Any future funding requirements will depend on many factors, including: • market acceptance of our products; • • • • • • • • • • • • the scope, rate of progress and cost of our clinical studies; the cost of our research and development activities; the cost of filing, defending and enforcing our patent or other intellectual property rights, in litigation or otherwise and any claims that our product infringes third-party patents or other intellectual property rights; the cost of defending, in litigation or otherwise, products liability claims; the cost and timing of additional regulatory clearances or approvals; the cost and timing of establishing additional sales, marketing and distribution capabilities; the scope, rate of progress and cost to expand ongoing manufacturing activities; costs associated with any product recall that may occur; the effect of competing technological and market developments; the extent to which we acquire or invest in products, technologies and businesses; the costs of operating as a public company; and the ability of third-parties to pay future invoices and obligations. If we raise additional funds by issuing equity securities, our stockholders may experience dilution. Any future debt financing into which we enter may impose covenants that restrict our operations, including limitations on our ability to incur liens or additional debt, pay dividends, repurchase our stock, make certain investments and engage in certain merger, consolidation or asset sale transactions. Any debt financing or additional equity that we raise may contain terms that are not favorable to us or our stockholders. If we raise additional funds through collaboration and licensing arrangements with third parties, it may be necessary to relinquish some rights to our technologies or our products, or grant licenses on terms that are not favorable to us. If we are unable to raise adequate funds, we may have to liquidate some or all of our assets, or delay, reduce the scope of or eliminate some or all of our development programs. We cannot be certain that additional funding will be available on acceptable terms, if at all. In particular, the impact of the COVID-19 pandemic is highly uncertain as to the availability of additional funding and the underlying terms of such funding. If we do not have, or are not able to obtain, sufficient funds, we may have to delay development or commercialization of our products or license to third parties the rights to commercialize products or technologies that we would otherwise seek to 35 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. commercialize. We also may have to reduce marketing, customer support or other resources devoted to our products or cease operations. Any of these factors could harm our operating results. Risks Related to Ownership of Our Common Stock Our stock price may be volatile, and you may not be able to resell shares of our common stock at or above the price you paid. The market price of our common stock could be subject to significant fluctuations. Market prices for securities of early-stage medical device, pharmaceutical and other life sciences companies have historically been particularly volatile. Some of the factors that may cause the market price of our common stock to fluctuate include: • • • • • • • • • • • • • • • a slowdown in the medical device industry or the general economy; inability to obtain adequate supply of the components for, or receive services for, any of our products, including due to supply or service interruptions, or inability to do so at acceptable prices; performance of third parties on whom we may rely, including for the manufacture of the components for our products, including their ability to comply with regulatory requirements, as well as distributors; the results of our current and any future clinical trials of our devices, including to support future product modifications; unanticipated or serious safety concerns related to the use of any of our products; the entry into, or termination of, key agreements, including key commercial partner agreements; the initiation of, material developments in or conclusion of litigation to enforce or defend any of our intellectual property rights or defend against the intellectual property rights of others; announcements by us, our commercial partners or our competitors of new products or product enhancements, clinical progress or the lack thereof, significant contracts, commercial relationships or capital commitments; competition from existing technologies and products or new technologies and products that may emerge; the loss of key employees; changes in estimates or recommendations by securities analysts, if any, who may cover our common stock; general and industry-specific economic conditions that may affect our research and development expenditures; the low trading volume and the high proportion of shares and convertible notes held by affiliates; changes in the structure of health care payment systems and insurance coverage related to our products and procedures that utilize our products; and period-to-period fluctuations in our financial results. Moreover, the stock markets in general have experienced substantial volatility that has often been unrelated to the operating performance of individual companies. These broad market fluctuations may also adversely affect the trading price of our common stock. In the past, following periods of volatility in the market price of a company’s securities, stockholders have often instituted class action securities litigation against those companies. Such litigation, if instituted, could result in substantial costs and diversion of management attention and resources, which could significantly harm our profitability and reputation. We incur costs and demands upon management as a result of complying with the laws and regulations affecting public companies. We will continue to incur significant legal, accounting and other expenses including costs associated with public company reporting requirements. We will also incur costs associated with corporate governance requirements, including requirements under the Sarbanes-Oxley Act, as well as new rules implemented by the SEC and The Nasdaq Stock Market LLC. Our executive officers, service providers and other personnel will need to devote substantial time to these rules and regulations. These rules and regulations are expected to increase our legal and financial compliance costs and to make some other activities more time consuming and costly. These rules and regulations may also make it difficult and expensive for us to obtain directors’ and officers’ liability insurance. As a result, it may be more difficult for us to attract and retain qualified individuals 36 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. to serve on our board of directors or as executive officers of the Company, which may adversely affect investor confidence and could cause our business or stock price to suffer. Anti-takeover provisions in our charter documents and under Delaware General Corporate Law could make an acquisition of the Company more difficult and may prevent attempts by our stockholders to replace or remove Company management. Provisions in our certificate of incorporation and bylaws may delay or prevent an acquisition or a change in management. In addition, because we are incorporated in Delaware, it is governed by the provisions of Section 203 of the Delaware General Corporate Law, which prohibits stockholders owning in excess of 15% of our outstanding voting stock from merging or combining with us. Although we believe these provisions collectively will provide for an opportunity to receive higher bids by requiring potential acquirers to negotiate with our board of directors, they would apply even if the offer may be considered beneficial by some stockholders. In addition, these provisions may frustrate or prevent any attempts by our stockholders to replace or remove then current management by making it more difficult for stockholders to replace members of the board of directors, which is responsible for appointing the members of management. We do not anticipate that we will pay any cash dividends in the foreseeable future. The current expectation is that we will retain future earnings to fund the development and growth of our business. As a result, capital appreciation, if any, of our common stock will be your sole source of gain, if any, for the foreseeable future. In addition, our ability to pay dividends is limited by covenants in our credit agreement. Additionally, we are a holding company, and our ability to pay dividends will be dependent upon our subsidiaries’ ability to make distributions, which may be restricted by covenants in our credit agreement or any future contractual obligations. Future sales and issuances of our common stock or other securities may result in significant dilution or could cause the price of our common stock to decline. We cannot predict what effect, if any, sales of our shares in the public market or the availability of shares for sale will have on the market price of our common stock. However, if certain of our existing stockholders sell, or indicate an intention to sell, substantial amounts of our common stock in the public market, the trading price of our common stock could decline. In addition, shares of common stock that are subject to outstanding options will become eligible for sale in the public market to the extent permitted by the provisions of various vesting agreements and Rules 144 and 701 under the Securities Act. If these additional shares are sold, or if it is perceived that they will be sold, in the public market, the trading price of our common stock could decline. The conversion of some or all of our outstanding convertible notes may also dilute the ownership interests of existing stockholders. Any sales in the public market of any shares of our common stock issuable upon such conversion, including pursuant to our registration statement on Form S-3 with respect to shares underlying these convertible notes, could negatively impact prevailing market prices of our common stock. In addition, the anticipated conversion of the convertible notes into shares of our common stock or a combination of cash and shares of our common stock could depress the price of our common stock. We also expect that additional capital may be needed in the future to fund our operations. To raise capital, we may sell common stock, preferred stock, convertible securities or such other equity securities in one or more transactions at prices and in a manner we determine from time to time. These sales, or the perception in the market that the holders of a large number of shares intend to sell shares, could reduce the market price of our common stock. The ownership of our common stock is currently highly concentrated, and may prevent you and other stockholders from influencing significant corporate decisions and may result in conflicts of interest that could cause our stock price to decline. As of December 31, 2019, our executive officers, directors, holders of 5% or more of our common stock and their respective affiliates beneficially owned a majority of our outstanding capital stock. As a result, this group of stockholders has the ability to control us through this ownership position. These stockholders may be able to determine all matters requiring stockholder approval. For example, these stockholders may be able to control elections of directors, amendments of our organizational documents or approval of any merger, sale of assets or other major corporate transaction. This may prevent or discourage unsolicited acquisition proposals or offers for our common stock that you may feel are in your best interest as one of our stockholders. The interests of this group of stockholders may not always coincide with your interests or the interests of other stockholders and they may act in a manner that advances their best interests and not necessarily those of other stockholders, including seeking a premium value for their common stock, and might affect the prevailing market price for our common stock. The limited public float and trading volume for our common stock may have an adverse impact and cause significant fluctuation of market price. 37 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Our common stock is held by a relatively small number of stockholders. Consequently, our common stock has a relatively small float and low average daily trading volume, which could affect a stockholder’s ability to sell our stock or the price at which it can be sold. In addition, future sales of substantial amounts of our common stock in the public market by those larger stockholders, or the perception that these sales could occur, may adversely impact the market price of the stock and our stock could be difficult for a stockholder to liquidate. There can be no assurance that an active trading market for our common stock will be sustained in the future. The lack of an active trading market may make it more difficult for you to sell your shares and could lead to our share price being depressed or more volatile. Our amended and restated certificate of incorporation designates the Court of Chancery of the State of Delaware and, the federal district courts of the United States of America as the exclusive forums for substantially all disputes between us and our stockholders, which will restrict our stockholders' ability to choose the judicial forum for disputes with us or our directors, officers, or employees. Our amended and restated certificate of incorporation and amended and restated bylaws each provide that, unless we consent in writing to an alternative forum, the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for the following types of actions or proceedings under Delaware statutory or common law: (i) any derivative action or proceeding brought on behalf of the corporation, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer, or other employee of the corporation to the corporation or the corporation’s stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, or (iv) any action asserting a claim governed by the internal affairs doctrine. The provisions would not apply to suits brought to enforce a duty or liability created by the Securities Act, the Exchange Act or any other claim for which the U.S. federal courts have exclusive jurisdiction. Our stockholders cannot waive compliance with the federal securities laws and the rules and regulations thereunder. In addition, our amended and restated bylaws provide that, unless we consent in writing to the selection of an alternative forum, the federal district courts of the United States of America will be the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act. The exclusive-forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees or agents, which may discourage such lawsuits against us and such persons. Moreover, if any court of competent jurisdiction were to find any exclusive-forum provision in our amended and restated certificate of incorporation or amended and restated bylaws to be inapplicable or unenforceable, we may incur additional costs associated with resolving such matters in other jurisdictions, which could harm our results of operations or financial condition. ITEM 1B. UNRESOLVED STAFF COMMENTS None. ITEM 2. PROPERTIES Our principal executive offices are located in an 18,388 square foot facility in Austin, Texas. The term of the lease for our Austin facility extends through September 30, 2021. Our principal office in Austin houses research and development, sales, marketing, finance and administrative activities. We operate an approximate 18,200 square foot manufacturing facility in the Coyol Free Trade Zone in Alajuela, Costa Rica. The term of the lease for our Costa Rica facility extends through October 31, 2021. Additionally, we have a research and development facility in Austin, Texas and sales and marketing offices in Australia, Italy, Brazil, and the United Kingdom. We believe that our facilities are currently adequate for our needs. ITEM 3. LEGAL PROCEEDINGS From time to time, we are involved in legal proceedings. The results of such legal proceedings and claims cannot be predicted with certainty, and regardless of the outcome, legal proceedings could have an adverse impact on our business because of defense and settlement costs, diversion of resources and other factors. ITEM 4. MINE SAFETY DISCLOSURES Not applicable. 38 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. PART II ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES Market Information Our common stock is listed for trading on the Nasdaq Global Market under the symbol "APEN". As of February 28, 2020, there were approximately 104 stockholders of record of our common stock. Certain shares are held in "street" name and accordingly, the number of beneficial owners of such shares is not known or included in the foregoing number. Dividend Policy We have never paid or declared any cash dividends on our common stock. We do not anticipate paying any cash dividends on our common stock in the foreseeable future, and we intend to retain all available funds and any future earnings to fund the development and expansion of our business. In addition, our ability to pay dividends is limited by covenants in our credit agreement. Any future determination to pay dividends will be at the discretion of our board of directors and will depend upon a number of factors, including our results of operations, financial condition, future prospects, contractual restrictions, restrictions imposed by applicable law and other factors our board of directors deems relevant. ITEM 6. SELECTED FINANCIAL DATA This item has been omitted as we qualify as a smaller reporting company as defined by Rule 12b-2 of the Exchange Act. ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS This annual report ("Annual 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 Act of 1934, as amended (the "Exchange Act"). These statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performances or achievements expressed or implied by the forward-looking statements. In some cases, you can identify forward-looking statements by terms such as "anticipates," "believes," "could," "estimates," "expects," "intends," "may," "plans," "potential," "predicts," "projects," "should," "will," "would," and similar expressions intended to identify forward-looking statements. Forward-looking statements reflect our current views with respect to future events, are based on assumptions, and are subject to risks, uncertainties and other important factors. In particular, statements, whether express or implied, concerning future operating results or the ability to generate sales, income or cash flow are forward-looking statements. They involve risks, uncertainties and assumptions that are beyond our ability to control or predict, including those discussed in Part II, Item 1A, of this Annual Report. Given these risks, uncertainties, and other important factors, you should not place undue reliance on these forward-looking statements. Also, forward-looking statements represent our estimates and assumptions only as of the date of this Annual Report. Except as required by law, we assume no obligation to update any forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, even if new information becomes available in the future. The following discussion should be read in conjunction with our consolidated financial statements and related notes contained elsewhere in this Annual Report on Form 10-K. "Apollo," Orbera®, OverStitch™, the Apollo logo and other trademarks, service marks and trade names of Apollo are registered marks of Apollo Endosurgery, Inc. in the U.S. and other jurisdictions. Overview We are a medical technology company primarily focused on the design, development and commercialization of innovative medical devices to advance gastrointestinal therapeutic endoscopy. We develop and distribute devices that are used by surgeons and gastroenterologists for a variety of procedures related to gastrointestinal defect and complication management or bariatric (weight loss) intervention. Our core products are the OverStitch Endoscopic Suturing System ("ESS") and Intragastric Balloon ("IGB") (most often branded as Orbera). In December 2018, we divested our Surgical product line. 39 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. We have offices in United Kingdom, Australia, Italy, and Brazil that oversee commercial activities outside the U.S. and a products manufacturing facility in Costa Rica. All other activities are managed and operated from facilities in Austin, Texas. Divestiture of the Surgical Product Line In December 2018, we entered into an Asset Purchase Agreement ("Purchase Agreement") and sold our Surgical product line to ReShape Lifesciences Inc. ("ReShape"). Our goal with this transaction was to increase our focus on our Endoscopy products and monetize a non-strategic asset. ReShape agreed to pay $17.0 million in cash, of which $10.0 million was paid at the closing of the transaction, $2.0 million was paid on the first anniversary of the closing date and an additional $2.0 million and $3.0 million remains payable on each of the second and third anniversary of the closing date, respectively. As additional consideration, we also received from ReShape substantially all of ReShape's assets exclusively related to their intragastric balloon product and as of December 31, 2018, we discontinued selling ReShape's intragastric balloon product. Upon completion of the ReShape transaction, the parties entered into a transition services agreement, supply agreement and distribution agreement pursuant to which, among other things, we will manufacture the Surgical product for ReShape for up to two years, serve as ReShape’s distributor of the Surgical product outside of the U.S. ("OUS") for up to one year and provide other specified services for defined periods of time. As of December 31, 2019, all transition and distribution services are complete. We remain obligated to perform manufacturing services through December 2020. We and ReShape each made customary representations, warranties, covenants and indemnities in the Purchase Agreement. Subject to certain limitations, we each agreed to indemnify the other party for certain matters, including breaches of representations, warranties and covenants in the Purchase Agreement. ReShape also granted us a security interest in substantially all of ReShape’s assets as security for the payment and performance of all of ReShape’s obligations under the Purchase Agreement until the earlier of either the satisfaction of all obligations or their completion of one or more qualified financings that aggregate to $15.0 million. In October 2019, ReShape provided notice to us that it had completed their qualified financings. Impact of COVID-19 on Our Business The recent COVID-19 pandemic has adversely impacted our sales levels, business operations and results of operations in March 2020, in particular due to significantly decreased procedures being performed that use our products across our markets and the economic contraction resulting in part from the pandemic. While the ultimate economic impact of the COVID-19 pandemic is highly uncertain, we expect our sales, business operations and results from operations will be adversely impacted to varying degrees for as long as the COVID-19 pandemic persists. See Item 1A. Risk Factors—Risks Related to Our Business—Our business will be adversely affected by the effects of the recent COVID-19 outbreak. Financial Operations Overview Revenues Our principal source of revenues are sales of our Endoscopy products. The majority of our sales come from direct markets where sales are made to the final end customers, typically healthcare providers. In other markets, we sell our products to distributors who resell our products to end users. Revenues between periods will be impacted by several factors, including physician procedures and therapy preferences, patient procedures and therapy preferences, other market trends, the stability of the average sales price we realize on products and changes in foreign exchange rates used to translate foreign currency denominated sales into U.S. dollars. Under the ReShape distribution agreement, we agreed to sell Surgical products to customers OUS up to one year to allow ReShape to establish their ability to sell to customers in these markets. Our product sales in 2019 include sales from these serviced markets. Other revenue includes amounts recognized for our digital aftercare support program, transition and supply services we rendered to ReShape and freight charged to customers. 40 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Cost of Sales Our ESS products, representing the majority of our Endoscopy product sales, have historically been purchased from third-party manufacturers, and our cost of sales for these products has consisted of the actual purchase price from these manufacturers plus an allocation of our internal overhead cost. Cost of sales for products which we manufacture includes raw materials, labor, and manufacturing overhead. Raw materials used in our manufacturing activity are generally not subject to substantial commodity price volatility, and most of our manufacturing costs are incurred in U.S. dollars. Cost of sales also includes excess and obsolete inventory charges, royalties, shipping, inspection and related costs incurred in making our products available for sale or use. Our gross margin will continue to be impacted by the shift in our revenue mix from Surgical to Endoscopy products. Our divested Surgical products historically had higher gross margins compared to our Endoscopy products. In addition, manufacturing overhead as a percentage of revenue between periods can fluctuate as a result of manufacturing rates and the degree to which manufacturing overhead is allocated to production during the period. We expect to improve gross margins as we complete certain identified gross margin improvement projects and improve capacity utilization of our manufacturing facility. Sales and Marketing Expense Sales and marketing expense primarily consists of salaries, commissions, benefits and other related costs, including stock-based compensation, for personnel employed in our sales, marketing and medical education departments. In addition, our sales and marketing expense includes costs associated with advertising, physician training, industry events and other promotional activities. General and Administrative Expense General and administrative expense primarily consists of salaries, benefits and other related costs, including stock-based compensation, for personnel employed in the corporate management, finance, legal, compliance, information technology and human resource departments. General and administrative expense also includes facilities cost, insurance, audit fees, legal fees, bad debt expense and costs to develop and maintain our intellectual property portfolio. Research and Development Expense Research and development expense includes product development, clinical trial costs, quality and regulatory compliance, consulting services, outside prototyping services, outside research activities, materials, depreciation and other costs associated with development of our products. Research and development expense also includes compensation and stock-based compensation expense for personnel dedicated to these activities. Research and development expense may fluctuate between periods depending on the activity associated with our various product development and clinical obligations. Amortization of Intangible Assets Definite-lived intangible assets primarily consist of customer relationships, product technology, trade names, patents and trademarks and capitalized software. Intangible assets are amortized over the asset's estimated useful life. Critical Accounting Policies and Estimates Our management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which management has prepared in accordance with existing U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenue and expenses during the reporting periods. Management evaluates estimates and judgments on an ongoing basis. Estimates relate to aspects of our revenue recognition, going concern, financial projections, useful lives with respect to intangible and long-lived assets, goodwill impairment, allowance for doubtful accounts, inventory valuation, stock compensation, deferred tax asset valuation and long-lived assets. We base our estimates on historical experience and on various other factors that management believes are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Our actual results may differ from these estimates under different assumptions or conditions. The critical accounting policies addressed below reflect our most significant judgments and estimates used in the preparation of our consolidated financial statements. 41 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Revenue Recognition Our principal source of revenues is from the sale of our products to hospitals, physician practices and distributors. We utilize a network of employee sales representatives in the U.S. and a combination of employee sales representatives, independent agents and distributors in OUS markets. The Company adopted the provisions of ASU 2014-09, Revenue from Contracts with Customers on January 1, 2018 as discussed in Note 2 to the Consolidated Financial Statements. Revenue is recognized when control of the promised goods is transferred to our customers, in an amount that reflects the consideration we expect to be entitled to in an exchange for those goods. Generally, these conditions are met upon product shipment. Customers generally have the right to return or exchange products purchased from us for up to thirty days from the date of product shipment. Distributors, who resell the products to their customers, take title to products and assume all risks of ownership at the time of shipment and are obligated to pay within specified terms regardless of when, if ever, they sell their products. At the end of each period, we determine the extent to which our revenues need to be reduced to account for expected rebates, returns and exchanges. We classify any shipping and handling cost billed to customers as revenue and the related expenses as cost of sales. In connection with the December 2018 sale of the Surgical product line, we entered into a transition services agreement, supply agreement and distribution agreement which obligated us to provide specific services for designated periods of time for each service, manufacture Surgical products for up to two years, and serve as ReShape's OUS distributor of Surgical product for up to one year. Transition service revenue is recognized as the support is provided in accordance with the prices established in the transition services agreement. Supply agreement revenue is recognized when products are shipped at the net amount earned based upon the prices established in the supply agreement less the cost to produce the product. Transition service and supply agreement revenue are included in other revenue. Pursuant to the OUS distribution agreement, we continued to sell products to customers and recognized OUS Surgical product sales in 2019 at the amounts charged to customers and reflected the cost of these products in cost of sales. Accounts Receivable and Allowance for Doubtful Accounts Accounts receivable are at the invoiced amount less an allowance for doubtful accounts. On a regular basis, we evaluate accounts receivable and estimate an allowance for doubtful accounts, as needed, based on various factors such as customers' current credit conditions, length of time past due and the general economy as a whole. We write off receivables against the allowance when they are deemed uncollectible. Inventory Inventory is stated at the lower of cost or net realizable value, net of any allowance for unsalable inventory. Charges for excess and obsolete inventory are based on specific identification of excess and obsolete inventory items and an analysis of inventory items approaching expiration date. We evaluate the carrying value of inventory in relation to the estimated forecast of product demand. A significant decrease in demand could result in an increase in the amount of excess inventory quantities on hand. When quantities on hand exceed estimated sales forecasts, we record estimated excess and obsolescence charges to cost of sales. Our inventories are stated using the weighted average cost approach, which approximates actual costs. Intangible and Long-lived Assets Definite-lived intangible assets consist of customer relationships, product technology, trade names, patents and trademarks, and capitalized software which are amortized over their estimated useful lives. Long-lived assets, including definite-lived intangible assets, are monitored and reviewed for impairment whenever events or circumstances indicate that the carrying value of any such asset may not be recoverable. The determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use of an asset and its eventual disposal. The estimate of undiscounted cash flows is based upon, among other things, certain assumptions about expected future operating performance. Our estimates of undiscounted cash flows may differ from actual cash flows. If the sum of the undiscounted cash flows is less than the carrying value of the asset, an impairment charge is recognized, measured as the amount by which the carrying value exceeds the fair value of the asset. Income Taxes We account for deferred income taxes using the asset and liability method. Under this method, deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. Temporary differences are then measured using the enacted tax rates and laws. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that is more-likely than-not to be realized. Determining the appropriate amount of valuation allowance requires management to exercise judgment about future operations. 42 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. In the ordinary course of business, there are many transactions for which the ultimate tax outcome is uncertain. We regularly assess uncertain tax positions in each of the tax jurisdictions in which we have operations and account for the related consolidated financial statement implications. The amount of unrecognized tax benefits is adjusted when information becomes available or when an event occurs indicating a change is appropriate. We include interest and penalties related to our uncertain tax positions as part of income tax expense. Non-GAAP Financial Measures To supplement our financial results, we are providing a non-GAAP financial measure, percentage revenue change in constant currency, which removes the impact of changes in foreign currency exchange rates that affect the comparability and trend of revenues compared to the same period of the prior year. Percentage revenue change in constant currency is calculated by translating current foreign currency sales using last year's exchange rate. This supplemental measure of our performance is not required by, and is not determined in accordance with GAAP. We believe the non-GAAP financial measure included herein is helpful in understanding our current financial performance. We use this supplemental non- GAAP financial measure internally to understand, manage and evaluate our business, and make operating decisions. We believe that making non-GAAP financial information available to investors, in addition to GAAP financial information, may facilitate more consistent comparisons between our performance over time with the performance of other companies in the medical device industry, which may use similar financial measures to supplement their GAAP financial information. However, our non-GAAP financial measure is not meant to be considered in isolation or as a substitute for the comparable GAAP metric. This measure should only be read in conjunction with our consolidated financial statements prepared in accordance with GAAP. Reconciliations for this non-GAAP financial measure to its most directly comparable GAAP financial measure is provided in the tables below. Results of Operations Comparison of the Years Ended December 31, 2019 and 2018 Revenues (1) Cost of sales Gross margin Operating expenses: Sales and marketing General and administrative Research and development Amortization of intangible assets Settlement gain Loss on divestiture Total operating expenses Loss from operations Interest expense, net Other (income) expense Net loss before income taxes Income tax expense Net loss Year Ended December 31, 2019 Year Ended December 31, 2018 Dollars % of Revenues Dollars % of Revenues $ $ 50,713 25,038 25,675 28,730 13,588 10,384 2,095 (5,609) — 49,188 (23,513) 4,052 (408) (27,157) 275 (27,432) 100.0 % $ 49.4 % 50.6 % 56.7 % 26.8 % 20.5 % 4.1 % (11.1) % — % 97.0 % (46.4) % 8.0 % (0.8) % (53.6) % 0.5 % (54.1) % $ 60,854 27,660 33,194 32,831 13,436 12,176 7,074 — 7,770 73,287 (40,093) 4,063 1,440 (45,596) 191 (45,787) 100.0 % 45.5 % 54.5 % 54.0 % 22.1 % 20.0 % 11.6 % — % 12.8 % 120.5 % (66.0) % 6.7 % 2.4 % (75.1) % 0.3 % (75.4) % (1) Revenue between periods declined $13.7 million due to the divestiture of the Surgical product line in December 2018. See the product sales table under "Revenues" for additional information for product group and geographic market. 43 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Revenues Product sales by product group and geographic market for the periods shown were as follows: Year Ended December 31, 2019 Year Ended December 31, 2018 % Increase / (Decrease) U.S. OUS Total Revenues U.S. OUS Total Revenues U.S. OUS Total Revenues ESS IGB Total Endoscopy Surgical Other $ 14,944 $ 13,365 $ 28,309 $ 11,016 $ 12,364 $ 23,380 5,162 20,106 — 1,815 11,678 25,043 3,712 37 16,840 45,149 3,712 1,852 5,400 16,416 10,795 995 12,339 24,703 7,913 32 17,739 41,119 18,708 1,027 Total revenues $ 21,921 $ 28,792 $ 50,713 $ 28,206 $ 32,648 $ 60,854 35.7 % (4.4)% 22.5 % (100.0)% 82.4 % (22.3)% 8.1 % (5.4)% 1.4 % (53.1)% 15.6 % (11.8)% 21.1 % (5.1)% 9.8 % (80.2)% 80.3 % (16.7)% % Total revenues 43.2 % 56.8 % 46.4 % 53.6 % Product sales percentage change in constant currency for the year ended December 31, 2019 were as follows: ESS IGB Total Endoscopy Surgical Other Total revenues % Increase/Decrease in Constant Currency OUS Total Revenues 12.5 % (1.6) % 5.5 % (50.2)% 23.9 % (8.0) % 23.4 % (2.5) % 12.3 % (79.0) % 80.6 % (14.6) % Total revenues in 2019 were $50.7 million, compared to $60.9 million in 2018, a decrease of 16.7%. The decline in total revenues was the result of divesting our Surgical products in December 2018. Total Endoscopy product sales increased 9.8% to $45.1 million in 2019 from $41.1 million in 2018. In constant currency, Endoscopy sales increased 12.3% when compared to 2018. Direct markets accounted for 79.3% and 81.6% of total Endoscopy product sales in 2019 and 2018, respectively. Total ESS product sales increased $4.9 million, or 21.1%, in 2019 when compared to 2018. In constant currency, total ESS product sales increased 23.4%. U.S. ESS product sales increased $3.9 million, or 35.7%, compared to 2018. OUS ESS product sales increased $1.0 million, or 8.1%, compared to 2018. In constant currency, OUS ESS product sales increased 12.5% when compared to 2018. Worldwide, ESS growth is due to increased sales volume from new user adoption, greater product utilization in our existing customer base and growth in distributor market sales. Total IGB product sales decreased $0.9 million, or 5.1%, in 2019 when compared to 2018. In the U.S., IGB product sales decreased $0.2 million, or 4.4%, in 2019 when compared to 2018 due to lower consumer demand in the first half of 2019 followed by a 23.2% increase in sales for the fourth quarter of 2019. We believe IGB product sales will continue to fluctuate quarter over quarter in the near term. OUS IGB product sales decreased $0.7 million, or 5.4%, in 2019 when compared to 2018 due to lower sales from lost market share in Brazil. In constant currency, OUS IGB product sales decreased 1.6% in 2019 when compared to 2018. Included in other revenues for 2019 is $1.3 million of transition and manufacturing services provided to ReShape. 44 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Cost of Sales Costs of product sales for the periods shown were as follow: Materials, labor and purchased goods Overhead Other indirect costs Total cost of sales Gross Margin Year Ended December 31, 2019 Year Ended December 31, 2018 Dollars % Total Revenues Dollars % Total Revenues 17,160 4,990 2,888 25,038 $ 33.8 % $ 9.9 % 5.7 % 49.4 % $ 18,009 6,670 2,981 27,660 29.6 % 11.0 % 4.9 % 45.5 % Gross margin was 50.6% for 2019 compared to 54.5% for 2018. The decline in gross margin is primarily due to a greater proportion of our overall product sales coming from our ESS products, which have experienced higher sales growth but have lower gross margins. Additionally, gross margin realized on remaining OUS Surgical product sales declined in 2019 as a result of the terms of the ReShape supply and distribution agreements. Gross margin for our Endoscopy products increased to 49.5% for 2019 compared to 44.2% for 2018 due to implementation of our gross margin improvement projects. Operating Expenses Sales and Marketing Expense. Sales and marketing expense decreased $4.1 million in 2019 as compared to 2018 primarily due to lower U.S. direct consumer advertising costs, lower sales compensation, and cost savings from insourcing our customer service operation at the end of 2018. General and Administrative Expense. General and administrative expense increased $0.2 million in 2019 as compared to 2018 primarily due to higher internal control audit fees incurred in the first quarter of 2019 required for our 2018 Annual Report on Form 10-K. Research and Development Expense. Research and development expense decreased $1.8 million in 2019 as compared to 2018 primarily due to lower clinical trial spend in 2019 as we completed the Orbera post-approval study. Amortization of Intangible Assets. Amortization of intangible assets decreased $5.0 million in 2019 as compared to 2018 due to the disposition of intangible assets associated with the Surgical business in December 2018. Settlement Gain. Settlement gain of $5.6 million in 2019 resulted from the resolution of a dispute with Allergan Inc. at a value less than amounts previously accrued for disputed inventory purchases and transition services provided by Allergan through 2016. Loss on Divestiture. Loss on divestiture of $7.8 million in 2018 was due to the divestiture of our Surgical product line in December 2018. Loss from Operations. Loss from operations in 2019 was $23.5 million compared to $40.1 million in 2018. Excluding the settlement gain and loss on divestiture, the loss from operations was $29.1 million in 2019 compared to $32.3 million in 2018. The decreased loss from operations, after excluding the one-time settlement gain and loss on divestiture, was primarily due to lower operating expenses offsetting the reduction in gross margin from the divestiture of our Surgical product line. Other Expenses Interest Expense, net. Net interest expense remained unchanged at $4.1 million in 2019 and 2018. Other (Income) Expense. Other (income) expense primarily consists of realized and unrealized foreign exchange gains or losses. The decrease of $1.8 million in 2019 compared to 2018 was primarily caused by the movement in exchange rates on short-term intercompany loans denominated in U.S dollars payable by our foreign subsidiaries. During 2019, unrealized exchange rate gains on these intercompany loans were $0.2 million compared to unrealized losses of $1.2 million in 2018. Income Tax Expense. Income tax expense was $0.3 million in 2019 compared to $0.2 million in 2018. Tax expense in 2019 and 2018 relates to foreign income taxes on income generated in our OUS tax jurisdictions. 45 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Comparison of the Years Ended December 31, 2018 and 2017 Revenues Cost of sales Gross margin Operating expenses: Sales and marketing General and administrative Research and development Amortization of intangible assets Loss on divestiture Total operating expenses Loss from operations Interest expense, net Other expense Net loss before income taxes Income tax expense Net loss Revenues Year Ended December 31, 2018 Year Ended December 31, 2017 Dollars % of Revenues Dollars % of Revenues $ $ 60,854 27,660 33,194 32,831 13,436 12,176 7,074 7,770 73,287 (40,093) 4,063 1,440 (45,596) 191 (45,787) 100.0 % $ 45.5 % 54.5 % 54.0 % 22.1 % 20.0 % 11.6 % 12.8 % 120.5 % (66.0) % 6.7 % 2.4 % (75.1) % 0.3 % (75.4) % $ 64,310 24,578 39,732 32,910 13,722 8,299 7,240 — 62,171 (22,439) 4,508 41 (26,988) 304 (27,292) 100.0 % 38.2 % 61.8 % 51.2 % 21.3 % 12.9 % 11.3 % — % 96.7 % (34.9) % 7.0 % 0.1 % (42.0) % 0.5 % (42.5) % Product sales by product group and geographic market for the periods shown were as follows: Year Ended December 31, 2018 Year Ended December 31, 2017 % Increase / (Decrease) U.S. OUS Total Revenues U.S. OUS Total Revenues U.S. OUS Total Revenues ESS IGB Total Endoscopy Surgical Other $ 11,016 $ 12,364 $ 23,380 $ 8,019 $ 8,462 $ 16,481 5,400 16,416 10,795 995 12,339 24,703 7,913 32 17,739 41,119 18,708 1,027 6,301 14,320 17,366 766 13,141 21,603 10,227 28 19,442 35,923 27,593 794 Total revenues $ 28,206 $ 32,648 $ 60,854 $ 32,452 $ 31,858 $ 64,310 37.4 % (14.3)% 14.6 % (37.8)% 29.9 % (13.1)% 46.1 % (6.1)% 14.3 % (22.6)% 14.3 % 2.5 % 41.9 % (8.8)% 14.5 % (32.2)% 29.3 % (5.4)% % Total revenues 46.4 % 53.6 % 50.5 % 49.5 % Total revenues in 2018 were $60.9 million, compared to $64.3 million in 2017, a decrease of 5.4%. Foreign currency fluctuations increased total revenues $0.3 million in 2018. Direct market sales accounted for approximately 87% of total revenues for both periods presented. ESS product sales increased 41.9% or $6.9 million in 2018 when compared to 2017. U.S. ESS product sales increased 37.4% or $3.0 million, compared to 2017 due to continued new user adoption and greater product utilization in existing accounts. OUS ESS product sales increased 46.1% or $3.9 million due to growth in Europe. IGB product sales decreased $1.7 million or 8.8% in 2018 compared to 2017. In the U.S., IGB product sales decreased $0.9 million in 2018 when compared to 2017 primarily due to decreased consumer demand after the June 2018 FDA letter to Health Care Professionals. OUS IGB product sales decreased $0.8 million in 2018 when compared to 2017 due to lower sales in Brazil and our distributor markets which offset growth of 14.6% in Europe due to higher unit sales and average selling prices of Orbera365 in Europe. Total Endoscopy product sales increased 14.5% to $41.1 million in 2018, compared to $35.9 million in 2017 comprising 67.6% of total revenues in 2018 compared to 55.9% in 2017. 46 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Total Surgical product sales for 2018 were $18.7 million, a decrease of 32.2%, compared to $27.6 million in 2017. The decline was primarily due to reductions in gastric banding procedures being performed. Surgical product sales in the U.S., decreased 37.8% to $10.8 million in 2018 compared to $17.4 million for 2017 and OUS Surgical sales decreased 22.6% to $7.9 million in 2018 compared to $10.2 million in 2017. Cost of Sales Cost of product sales for the periods shown were as follows: Materials, labor and purchased goods Overhead Change in inventory reserve Other indirect costs Total cost of sales Gross Margin Year Ended December 31, 2018 Year Ended December 31, 2017 Dollars % Total Revenues Dollars % Total Revenues $ $ 18,009 6,670 387 2,594 27,660 29.6 % $ 11.0 % 0.6 % 4.3 % 45.5 % $ 15,896 5,416 692 2,574 24,578 24.7 % 8.4 % 1.1 % 4.0 % 38.2 % Gross margin as a percentage of revenues was 54.5% for 2018 compared to 61.8% for 2017, respectively. The decline in gross margin is primarily due to a shift in our product sales mix from higher margin Surgical products to Endoscopy products that realize lower relative gross margins. Additionally, finished goods inventory was higher at the end of 2017 as we built up inventory levels to protect against the risk of supply disruption while we completed gross margin improvement projects during 2018. With the completion of these projects in 2018, our finished goods inventory at the end of 2018 has been substantially reduced which resulted in a greater proportion of our manufacturing overhead getting charged to cost of sales during 2018 compared to 2017. Although overhead charged to cost of sales is higher in 2018 for the above reason compared to 2017, our overhead spend is materially unchanged between the years. Operating Expenses Sales and Marketing Expense. Sales and marketing expense of $32.8 million for 2018 decreased $0.1 million from 2017. General and Administrative Expense. General and administrative expense decreased $0.3 million in 2018 as compared to 2017 primarily due to higher costs incurred to meet our public company filing requirements in the previous year. Research and Development Expense. Research and development expense increased $3.9 million in 2018 compared to 2017 primarily due to higher clinical trial activities associated with our Endoscopy products and higher costs for new product development and product margin improvement projects. Loss on Divestiture. Loss on divestiture of $7.8 million was due to the divestiture of our Surgical product line in December 2018. Amortization of Intangible Assets. Amortization of intangible assets decreased $0.2 million in 2018 when compared to 2017 due to the divestiture of Surgical related intangibles. Loss from Operations Loss from operations in 2018 was $40.1 million compared to $22.4 million in 2017. The increased loss from operations was primarily due to lower gross margins, higher research and development expenses, and the loss on divestiture. Other Expenses Interest Expense. Interest expense decreased $0.4 million, or 9.9%, in 2018 compared to 2017 due to principal payments on our senior secured credit facility. Other Expense. Other expense primarily consists of realized and unrealized foreign exchange gains or losses. The increase of $1.4 million in 2018 compared to 2017 was primarily caused by the movement in exchange rates on short-term intercompany loans denominated in U.S dollars payable by our foreign subsidiaries. During 2018, unrealized exchange rate losses on these intercompany loans were $1.2 million compared to unrealized gains of $0.2 million in 2017. 47 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Income Tax Expense. Income tax expense was $0.2 million in 2018 compared to $0.3 million in 2017. We established a valuation allowance equal to the total U.S. net deferred tax assets due to our lack of earnings history. Tax expense in 2018 and 2017 relates to foreign income taxes on income generated in our OUS tax jurisdictions. Liquidity and Capital Resources We have experienced operating losses since inception and occasional debt covenant violations and have an accumulated deficit of $250.2 million as of December 31, 2019. To date, we have funded our operating losses and acquisitions through equity offerings and the issuance of debt instruments. Our ability to fund future operations and meet debt covenant requirements will depend upon our level of future revenue and operating cash flow and our ability to access additional funding through either equity offerings, issuances of debt instruments or both. We expect our negative cash flows from operating activities to continue and have determined that our losses and negative cash flows from operations along with the uncertainty of the current COVID-19 pandemic raise substantial doubt about our ability to meet our debt covenant requirements for at least one year from the issuance date of these Consolidated Financial Statements. See Item 1A. Risk Factors—Risks Related to Our Business—Our business will be adversely affected by the recent COVID-19 outbreak. We will likely require additional funding to remain in compliance, depending upon events that are difficult to predict at this time. In this regard, management’s plans to meet any additional operating cash flow requirements include the pursuit of strategic alternatives to finance our business plan, including, but not limited to sales of our common stock, preferred stock, convertible debt securities or debt financings, reduction of planned expenditures, or other sources. As of December 31, 2019, cash, cash equivalents, and restricted cash was $30.9 million. There are no assurances that such additional funding will be obtained, and we cannot predict the impact of COVID-19 on our operations and ability to access the additional funding we may need. If we cannot successfully raise additional capital and implement our strategic development plan, our liquidity, financial condition and business prospects will be materially and adversely affected. Term Loan Facility In March 2019, we entered into a term loan facility agreement with Solar Capital, Ltd. to borrow $35.0 million (the "Credit Agreement"). The Credit Agreement matures on September 1, 2023, with principal payments beginning in 2021, and bears interest at LIBOR plus 7.5%. Principal payments are due on a straight-line basis after the interest-only period concludes. An additional 4.9% of the outstanding amount will be due at end of the loan term and an additional 4.5% fee of the Term Loan funded amount will be due at the earlier of an Exit Event (as defined in the Credit Agreement) or if we achieve trailing twelve-month revenue of $100.0 million before March 15, 2029. The Credit Agreement includes customary affirmative covenants, negative covenants and financial covenants, including a minimum liquidity requirement and minimum product revenues. We used $22.4 million of the proceeds of the Credit Agreement to repay our previous senior secured credit agreement in full, including interest. In June 2019, we entered into the First Amendment to the Credit Agreement which adjusted the trailing six-month Endoscopy revenue requirements for the periods ending June 30, July 31, and August 31, 2019 and increased the minimum liquidity covenant to $12.5 million. In August 2019, we entered into the Second Amendment to the Credit Agreement to allow for the issuance of up to $20.0 million aggregate principal amount of 6.0% convertible senior debentures due 2024 (the "Convertible Debt"). In October 2019, we entered into the Third Amendment to the Credit Agreement that adjusted the trailing six-month Endoscopy revenue requirements for the periods ending August 31, 2019 through December 31, 2019. In March 2020, we entered into the Fourth Amendment and Limited Waiver to the Credit Agreement which established our 2020 revenue covenant requirements, provides an additional $10 million of funding upon the achievement of these revenue requirements through June 2020, and waived the financial statement covenant default associated with the issuance of a going concern opinion by our independent registered public accounting firm for the year ended December 31, 2019. See Note 19 of the Notes to the Consolidated Financial Statements. The Credit Agreement is classified as a current liability on the balance sheet at December 31, 2019, based on our assessment that we may not be able to meet our debt covenant requirements for at least one year from the issuance of our Consolidated Financial Statements considering factors such as the uncertainties from the COVID-19 pandemic. Should we fall short of the target, we would seek a waiver of this provision. There can be no assurances that we would be successful in obtaining a waiver. 48 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Convertible Senior Debt In August 2019, we issued $20.0 million aggregate principal amount of Convertible Debt. Interest on the Convertible Debt will be payable semi-annually in shares of our common stock on January 1 and July 1 of each year, beginning on January 1, 2020, at a rate of 6.0% per year. The number of shares of common stock required to settle the amount of interest payable will be based on the volume-weighted average price ("VWAP"), of our common stock for the 10 consecutive trading days immediately preceding the applicable interest payment date. The Convertible Debt will mature on August 12, 2024 unless earlier converted or repurchased in accordance with its terms. The Convertible Debt converts, at the option of the holders, into shares of our common stock at an initial conversion price of $3.25 per share, subject to adjustment. If the VWAP of our common stock has been at least $9.75 (subject to adjustment) for at least 20 trading days during any 30 consecutive trading day period, we may force the conversion of all or any part of the outstanding principal amount of the Convertible Debt, accrued and unpaid interest and any other amounts then owing, subject to certain conditions. Cash Flows The following table provides information regarding our cash flows for the years ended December 31, 2019 and 2018: Net cash used in operating activities Net cash provided by investing activities Net cash provided by financing activities Effect of exchange rate changes on cash Net change in cash, cash equivalents and restricted cash Operating Activities 2019 2018 (25,622) $ (23,119) 1,038 30,506 (8) 5,914 $ 7,119 9,695 (106) (6,411) $ $ Cash used in operating activities of $25.6 million for 2019 was primarily the result of a net loss of $27.4 million plus non-cash items of $1.3 million primarily related to the settlement gain of $5.6 million offset by depreciation, amortization, non-cash interest expense, and stock based compensation. The increase in net loss after adjustment for non-cash items is primarily due to the divestiture of our Surgical product line in December of 2018. Additionally, cash provided by operating assets and liabilities of $0.6 million related to working capital changes primarily from accounts receivable collections and reduction in inventory levels offset by higher accounts payable payments. Cash used in operating activities of $23.1 million for 2018 was primarily the result of a net loss of $45.8 million net of non-cash charges of $21.0 million primarily related to depreciation, amortization, loss on divestiture of the Surgical product line, stock based compensation, and foreign exchange on intercompany loans. Net loss included $3.2 million of additional costs associated with clinical trial activities for our Endoscopy products. In addition, operating assets and liabilities provided cash of $1.6 million primarily due to reduction in inventory levels as we reduced our buffer stock in connection with completion of gross margin projects. The increase in cash for operating activities of $9.8 million in 2018 compared to 2017 primarily relates to the change in net loss, net of non-cash charges, as a result of lower gross margin and higher research and development expense each as explained above in our results of operations. Investing Activities Cash provided by investing activities of $1.0 million for 2019 was primarily related to the $2.0 million installment cash payment received for the sale of the Surgical product line offset by $1.0 million of investments in property and equipment and in our intellectual property portfolio. Cash provided by investing activities of $7.1 million for 2018 was primarily related to the $10.0 million closing cash payment received upon the sale of the Surgical product line offset by $2.9 million of purchases of property and equipment associated with our manufacturing facility as we expand manufacturing capability and ongoing investments in our intellectual property portfolio. Financing Activities Cash provided by financing activities of $30.5 million for 2019 primarily related to the $13.3 million in net proceeds from the Term Loan Facility refinancing and proceeds from the issuance of $20.0 million aggregate principal amount of Convertible Debt offset by deferred financing costs of $2.9 million. 49 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Cash provided by financing activities of $9.7 million for 2018 primarily related to the $21.9 million in net proceeds from the June 2018 public offering offset by payments of $12.5 million in principal on the senior secured credit facility. Future Funding Requirements As of December 31, 2019, we had cash, cash equivalents and restricted cash balances totaling $30.9 million. We cannot be certain that our existing cash and cash equivalents will continue to be adequate to fund our operations, or that additional financing will be available when needed, or that, if available, financing will be obtained on terms favorable to us or our stockholders. If we raise additional funds by issuing equity or convertible securities, substantial dilution to existing stockholders will likely result. If we raise additional funds by incurring new debt obligations, the terms of the debt will likely require significant cash payment obligations as well as covenants and specific financial ratios that may restrict our ability to operate our business. As discussed in Note 1 of the Notes to the Consolidated Financial Statements , we have the responsibility to evaluate whether conditions or events raise substantial doubt about our ability to meet our future financial obligations as they become due within one year after the date the financial statements are issued. This evaluation initially cannot take into consideration the potential mitigating effects of plans that have not been fully implemented as of the date the financial statements are issued. Since we currently anticipate that our existing capital resources will not enable us to meet our debt covenant requirements through March 2021 and due to uncertainty associated with the impact that the COVID-19 pandemic will have on our business, we have determined the accounting standard has been met for raising substantial doubt about our ability to continue as a going concern within one year of the issuance date of these financial statements. Any future capital requirements will depend on many factors including the severity and duration of the current COVID-19 pandemic on our business and capital markets, market acceptance of our products, the cost of our research and development activities, the cost and timing of additional regulatory clearances or approvals, the cost and timing of identified gross margin improvement projects, the cost and timing of clinical programs, the ability to maintain covenant compliance of our lending facility, and the costs and timing of sales, marketing, distribution and manufacturing activities. Off-balance Sheet Arrangements We do not have any off-balance sheet arrangements as defined by rules enacted by the SEC and accordingly, no such arrangements are likely to have a current or future effect on our financial position. Recent Accounting Pronouncements See Note 2(r) to the Consolidated Financial Statements in Part II, Item 8 of this Annual Report for a discussion of recently enacted accounting pronouncements. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK This item has been omitted as we qualify as a smaller reporting company as defined by Rule 12b-2 of the Exchange Act. 50 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. ITEM 8. FINANCIAL STATEMENTS APOLLO ENDOSURGERY, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations and Comprehensive Loss Consolidated Statements of Changes in Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 51 Page 52 53 54 55 56 57 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Report of Independent Registered Public Accounting Firm To the Stockholders and Board of Directors Apollo Endosurgery, Inc: Opinion on the Consolidated Financial Statements We have audited the accompanying consolidated balance sheets of Apollo Endosurgery, Inc. and subsidiaries (the “Company”) as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes (collectively, the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company as of December 31, 2019 and 2018, and the results of its operations and its cash flows for the years then ended, in conformity with U.S. generally accepted accounting principles. Going Concern The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note 1 to the consolidated financial statements, the Company has suffered recurring losses from operations, cash flow deficits and debt covenant violations and has an accumulated deficit that raise substantial doubt about its ability to continue as a going concern. Management’s plans in regard to these matters are also described in Note 1. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Basis for Opinion These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB. We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits, we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over financial reporting. Accordingly, we express no such opinion. Our audits included performing procedures to assess the risks of material misstatement of the consolidated financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the consolidated financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the consolidated financial statements. We believe that our audits provide a reasonable basis for our opinion. /s/ KPMG LLP We have served as the Company’s auditor since 2014. Austin, Texas March 26, 2020 52 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. APOLLO ENDOSURGERY, INC. AND SUBSIDIARIES Consolidated Balance Sheets December 31, 2019 and 2018 (In thousands, except for share data) Assets Current assets: Cash and cash equivalents Accounts receivable, net of allowance for doubtful accounts of $ 658 and $ 559, respectively Inventory, net Prepaid expenses and other current assets Total current assets Restricted cash Property, equipment and right-of-use assets Goodwill Intangible assets, net of accumulated amortization of $ 11,648 and $ 9,455, respectively Other assets Total assets Liabilities and Stockholders' Equity Current liabilities: Accounts payable Accrued expenses Current portion of long-term debt Total current liabilities Long-term debt Convertible debt Long-term liabilities Total liabilities Commitments and contingencies Stockholders' equity: Common stock; $ 0.001 par value; 100,000,000 shares authorized; 20,951,963 and 21,899,522 shares issued and outstanding at December 31, 2019 and 2018, respectively Additional paid-in capital Accumulated other comprehensive income Accumulated deficit Total stockholders' equity Total liabilities and stockholders' equity See accompanying notes to the consolidated financial statements. 53 2019 2018 $ 29,905 $ 23,996 9,232 8,865 2,998 51,000 1,016 6,612 5,290 7,831 2,833 11,391 9,932 2,801 48,120 1,011 5,897 5,290 9,859 4,291 $ $ 74,582 $ 74,468 9,902 $ 15,292 8,438 34,449 52,789 — 18,554 1,116 72,459 9,156 — 24,448 21,190 — — 45,638 21 22 250,634 249,115 1,630 2,501 (250,162) (222,808) 2,123 28,830 $ 74,582 $ 74,468 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. APOLLO ENDOSURGERY, INC. AND SUBSIDIARIES Consolidated Statements of Operations and Comprehensive Loss Years Ended December 31, 2019 and 2018 (In thousands, except for share data) Revenues Cost of sales Gross margin Operating expenses: Sales and marketing General and administrative Research and development Amortization of intangible assets Settlement gain Loss on divestiture Total operating expenses Loss from operations Other expenses: Interest expense, net Other (income) expense Net loss before income taxes Income tax expense Net loss Other comprehensive income (loss): Foreign currency translation Comprehensive loss Net loss per share, basic and diluted 2019 2018 $ 50,713 $ 25,038 25,675 28,730 13,588 10,384 2,095 (5,609) — 49,188 (23,513) 4,052 (408) (27,157) 275 $ $ $ (27,432) $ (871) (28,303) $ (1.27) $ 60,854 27,660 33,194 32,831 13,436 12,176 7,074 — 7,770 73,287 (40,093) 4,063 1,440 (45,596) 191 (45,787) 706 (45,081) (2.31) Shares used in computing net loss per share, basic and diluted 21,542,284 19,789,867 See accompanying notes to the consolidated financial statements. 54 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. APOLLO ENDOSURGERY, INC. AND SUBSIDIARIES Consolidated Statements of Changes in Stockholders’ Equity Years Ended December 31, 2019 and 2018 (In thousands, except for share data) Balances at December 31, 2017 Exercise of common stock options Issuance of restricted stock units Issuance of common stock, net of issuance costs of $1,843 Stock based compensation Foreign currency translation Net loss Balances at December 31, 2018 Adoption of ASU 2016-02, Leases Exercise of common stock options Exchange of common stock for warrants Issuance of restricted stock units Stock based compensation Foreign currency translation Net loss Balances at December 31, 2019 Common Stock Shares Amount Additional Paid-in Capital Accumulated Other Comprehensive Income 17,291,209 $ 17 $ 225,122 $ 1,795 Accumulated Deficit (177,021) $ 49,913 Total $ 275,862 23,361 4,309,090 — — — — — 5 — — — 738 — 21,852 1,403 — — — — — — 706 — — — — — — 738 — 21,857 1,403 706 (45,787) (45,787) 21,899,522 $ 22 $ 249,115 $ 2,501 $ (222,808) $ 28,830 — 17,158 (1,000,000) 35,283 — — — — — (1) — — — — — 31 1 — 1,487 — — — — — — — (871) — 78 — — — — — 78 31 — — 1,487 (871) (27,432) (27,432) 20,951,963 $ 21 $ 250,634 $ 1,630 $ (250,162) $ 2,123 See accompanying notes to the consolidated financial statements. 55 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. APOLLO ENDOSURGERY, INC. AND SUBSIDIARIES Consolidated Statements of Cash Flows Years Ended December 31, 2019 and 2018 (In thousands) Cash flows from operating activities: Net loss Adjustments to reconcile net loss to net cash used in operating activities: Depreciation and amortization Amortization of deferred financing costs Non-cash interest Provision for doubtful accounts receivable Inventory impairment Stock based compensation Unrealized foreign exchange on short-term intercompany loans Settlement gain Loss on divestiture Changes in operating assets and liabilities: Accounts receivable Inventory Prepaid expenses and other assets Accounts payable and accrued expenses Net cash used in operating activities Cash flows from investing activities: Purchases of property and equipment Purchases of intangibles and other assets Proceeds from sale of equipment Divestiture of Surgical product line Net cash provided by investing activities Cash flows from financing activities: Proceeds from exercise of stock options Proceeds from long-term debt Proceeds from convertible debt Proceeds from issuance of common stock Payments of deferred financing costs Payment of long-term debt Net cash provided by financing activities Effect of exchange rate changes on cash Net increase (decrease) in cash, cash equivalents and restricted cash Cash, cash equivalents and restricted cash at beginning of year Cash, cash equivalents and restricted cash at end of year Supplemental disclosure of cash flow information: Cash paid for interest Cash paid for income taxes Right-of-use assets recognized in exchange for new lease obligations (non-cash) 2019 2018 $ (27,432) $ (45,787) 4,060 620 540 212 162 1,487 (214) (5,609) — 1,852 872 (120) (2,052) (25,622) (805) (175) 18 2,000 1,038 31 35,000 20,000 — (2,857) (21,668) 30,506 (8) 5,914 25,007 $ $ 30,921 $ 3,470 $ 328 2,890 9,292 491 359 186 387 1,403 1,161 — 7,770 (162) 3,004 41 (1,264) (23,119) (1,951) (930) — 10,000 7,119 738 — — 21,857 (400) (12,500) 9,695 (106) (6,411) 31,418 25,007 3,775 98 — See accompanying notes to the consolidated financial statements. 56 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. APOLLO ENDOSURGERY, INC. AND SUBSIDIARIES Notes to Consolidated Financial Statements Years Ended December 31, 2019 and 2018 (In thousands, except for share data) (1) Organization and Business Description Apollo Endosurgery, Inc. is a Delaware corporation with both domestic and foreign wholly-owned subsidiaries. Throughout these Notes "Apollo" and the "Company" refer to Apollo Endosurgery, Inc. and its consolidated subsidiaries. Apollo is a medical technology company primarily focused on the design, development, and commercialization of innovative medical devices. The Company's products are used by gastroenterologists to address a variety of closure needs in the gastrointestinal tract and used by gastroenterologists and bariatric surgeons to treat obesity. The Company's core products include the OverStitch ™ Endoscopic Suturing System ("ESS") and the Orbera® Intragastric Balloon System ("IGB"), which together comprise the Company's Endoscopy products. The Company also offers Orbera® Coach, a digital and remotely delivered aftercare program. All devices are regulated by the U.S. Food and Drug Administration (the "FDA") or an equivalent regulatory body outside the U.S. The Company has offices in the United Kingdom, Australia, Italy, and Brazil that oversee commercial activities outside the U.S., and a products manufacturing facility in Costa Rica. All other activities are managed and operated from facilities in Austin, Texas. In December 2018, the Company sold its Lap-Band® adjustable gastric banding system ("Surgical") product line to ReShape Lifesciences, Inc ("ReShape") for total cash consideration of $17,000 ("Cash Purchase Price"), of which $ 10,000 was paid at closing and $ 2,000 was paid in December 2019. An additional $2,000 and $ 3,000 is payable on the second and third anniversary of the closing date, respectively. As additional consideration, the Company received substantially all of ReShape's assets exclusively related to ReShape's intragastric balloon product line. Effective December 31, 2018, the Company ceased sales of ReShape's intragastric balloon system. Additionally, the Company entered into a transition services agreement, supply agreement and distribution agreement with ReShape to manufacture Surgical products for ReShape for up to two years, serve as ReShape’s distributor of Surgical product outside the U.S. ("OUS") for up to one year and provide other specified services for defined periods of time. As of December 31, 2019, the Company's obligations under the transition and distribution agreements have been completed. Going Concern Uncertainty ASC Topic 205-40, Presentation of Financial Statements - Going Concern (“ASC 205-40”), requires management to assess the Company’s ability to continue as a going concern for one year after the date the financial statements are issued. Under ASC 205-40, management has the responsibility to evaluate whether conditions and/or events raise substantial doubt about the Company’s ability to meet future financial obligations as they become due within one year after the date that the financial statements are issued. As required by this standard, management’s evaluation shall initially not take into consideration the potential mitigating effects of management’s plans that have not been fully implemented as of the date the financial statements are issued. The Company has experienced operating losses since inception and expects its negative cash flows from operating activities to continue and has determined that the Company’s existing capital resources are not sufficient to ensure compliance with debt covenant requirements through March 2021. This projection along with the general uncertainty associated with the current COVID-19 pandemic has raised substantial doubt about the Company’s ability to continue as a going concern within one year of the issuance date of these Consolidated Financial Statements. The Company will likely require additional funding in order to meet its covenant requirements. In this regard, management’s plans include the pursuit of strategic alternatives to finance our business plan, including, but not limited to sales of our common stock, preferred stock, convertible debt securities or debt financings, reduction of planned expenditures, or other sources. There are no assurances that such additional funding will be obtained and that the Company will succeed in its future operations. If the Company cannot successfully raise additional capital and implement its strategic development plan, its liquidity, financial condition and business prospects will be materially and adversely affected. 57 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (2) Significant Accounting Policies (a) Principles of Consolidation The consolidated financial statements include the accounts of the Company and all of its wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. (b) Use of Estimates The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the U.S. ("U.S. GAAP") requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenues and expenses during the reporting periods. Actual results are likely to differ from those estimates, and such differences may be material to the consolidated financial statements. Significant items subject to such estimates and assumptions include revenue recognition, going concern, financial projections, useful lives of intangibles and long-lived assets, stock compensation, deferred tax asset valuation, long-lived asset and goodwill impairment, allowance for doubtful accounts, and valuation of inventory. (c) Cash and Cash Equivalents The Company considers all highly liquid investments with a remaining maturity at date of purchase of three months or less to be cash equivalents. (d) Restricted Cash The Company entered into irrevocable letters of credit with three banks to secure obligations under lease agreements and performance based obligations. These letters of credit are secured by cash balances totaling $1,016 and $ 1,011 which are recorded in restricted cash on the consolidated balance sheet as of December 31, 2019 and 2018, respectively. (e) Accounts Receivable The Company generally extends credit to certain customers without requiring collateral. The Company provides an allowance for doubtful accounts based on management's evaluation of the collectability of accounts receivable. Accounts receivable are written off when it is deemed uncollectible. The recorded allowance for doubtful accounts was $658 and $ 559 as of December 31, 2019 and 2018, respectively. Accounts receivable of $ 127 and $ 101 were written off during the years ended December 31, 2019 and 2018, respectively. (f) Inventory Inventory is stated at the lower of cost or net realizable value, net of any allowances. Charges for excess and obsolete inventory are based on specific identification of obsolete inventory items and an analysis of inventory items approaching expiration date. The Company records estimated excess and obsolescence charges to cost of sales. The Company's inventories are stated using the weighted average cost approach, which approximates actual costs. (g) Fair Value Measurements The carrying amounts of the Company's financial instruments, which primarily include cash and cash equivalents, accounts receivable, accounts payable and accrued expenses, approximate their fair values due to their short maturities. The fair value of the Company's long-term debt is estimated by management to approximate $38,000 and $ 21,935 at December 31, 2019 and 2018, respectively. The Company's convertible debt is estimated by management to approximate $20,000 at December 31, 2019. Management's estimates are based on comparisons of the characteristics of the Company's obligations, comparable ranges of interest rates on recently issued debt, and maturity. Such valuation inputs are considered a Level 3 measurement in the fair value valuation hierarchy. The accounting guidance defines fair value, establishes a consistent framework for measuring fair value and expands disclosure for each major asset and liability category measured at fair value on either a recurring or nonrecurring basis. Fair value is defined as an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the accounting guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows: 58 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Level 1: Observable inputs such as quoted prices in active markets; Level 2: Inputs, other than the quoted prices in active markets, that are observable either directly or indirectly; and Level 3: Unobservable inputs in which there is little or no market data, which require the reporting entity to develop its own assumptions. (h) Property and Equipment Property and equipment are carried at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets, except for leasehold improvements, which are depreciated straight-line over the shorter of the estimated useful life or the life of the lease. Major renewals and betterments are capitalized. Validation costs (including materials and labor) that are required to bring machinery to working condition are capitalized. Expenditures for repairs and maintenance and minor replacements are charged to expense as incurred. (i) Leases On January 1, 2019, the Company adopted the provisions of ASU 2016-02, Leases ("ASU 2016-02") under the modified retrospective approach, chose not to adjust comparative periods, and elected the package of practical expedients permitted under the transition guidance, which among other things, allowed us to carry forward the historical lease classification. The cumulative-effect adjustment made to the opening balance of retained earnings as of January 1, 2019 was $78. All significant lease arrangements are generally recognized at lease commitment. Operating lease right-of-use assets and liabilities are recognized at commencement based on the present value of lease payments over the lease term, except for leases with an initial term of 12 months or less, for which lease expense is recognized as incurred over the lease term. Right-of-use assets represent the Company’s right to use an underlying asset during the reasonably certain lease term, and lease liabilities represent the Company’s obligation to make lease payments arising from the lease. Lease terms may include options to extend or terminate the lease when its reasonably certain that the Company will exercise that option. The Company primarily uses its incremental borrowing rate based on the information available at commencement date in determining the present value of lease payments. Operating lease right-of-use assets include any lease payments related to initial direct costs and prepayments and excludes lease incentives. Lease expense is recognized on a straight-line basis over the lease term. The Company has lease agreements with lease and non-lease components, which are generally accounted for separately. (j) Goodwill and Other Intangible Assets Goodwill is not amortized but is tested annually for impairment or more frequently if impairment indicators exist. For annual and interim goodwill impairment tests, the Company first assesses qualitative factors before performing a quantitative assessment of the fair value of a reporting unit. If it is determined on the basis of qualitative factors that the fair value of the reporting unit is more likely than not less than the carrying amount, a quantitative impairment test is required. The Company's evaluation of goodwill completed on December 31, 2019 and 2018 resulted in no impairment losses. Definite-lived intangible assets consist of customer relationships, product technology, trade names, patents and trademarks and capitalized software which are amortized over their estimated useful lives. Costs to extend the lives of and renew patents and trademarks are capitalized when incurred. (k) Valuation of Long-Lived Assets Long-lived assets, including definite-lived intangible assets, are monitored and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of any such asset may not be recoverable. The determination of recoverability is based on an estimate of undiscounted cash flows expected to result from the use of an asset and its eventual disposition. The estimate of undiscounted cash flows is based upon, among other things, certain assumptions about expected future operating performance. The Company's estimates of undiscounted cash flows may differ from actual cash flows. If the sum of the undiscounted cash flows is less than the carrying value of the asset, an impairment charge is recognized, measured as the amount by which the carrying value exceeds the fair value of the asset. The Company's evaluation of long-lived assets for the years ended December 31, 2019 and 2018 resulted in no impairment losses. 59 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (l) Revenue Recognition The Company's principal source of revenues is from the sale of its products. Revenue is recognized when control of the promised goods is transferred to the customer, in an amount that reflects the consideration expected to be entitled to in an exchange for those goods. Generally, these are met under the Company's agreements with most customers upon product shipment. This includes sales to distributors, who sell the products to their customers, take title to the products and assume all risks of ownership at the time of shipment. The Company's distributors are obligated to pay within specified terms regardless of when, if ever, they sell the products. Customers and distributors generally have the right to return or exchange products purchased from the Company for up to thirty days from the date of product shipment. At the end of each period, the Company determines the extent to which its revenues need to be reduced to account for expected returns and exchanges. Certain customer may receive volume rebates or discounts, which are accounted for as variable consideration. The Company estimates these amounts based on the expected amount to be provided to customers and reduce revenues recognized. The Company records deferred revenues when cash payments are received in advance of the transfer of goods. The Company accounts for taxes collected from customers and remitted to governmental authorities on a net basis. Accordingly, such amounts are excluded from revenues. Amounts billed to customers related to shipping and handling are included in revenues. Shipping and handling costs related to revenue producing activities are included in cost of sales. In connection with the December 2018 sale of the Surgical product line, the Company entered into a transition services agreement, supply agreement and distribution agreement. Transition service fees were recognized as revenue when the support was provided in accordance with the prices established in the transition services agreement. Product sold under the supply agreement is recognized as revenue when product is shipped at the prices established in the supply agreement net of the cost to produce the product. Transition service and supply agreement revenue are included in other revenue. Product sold by the Company to customers pursuant to the distribution agreement is recognized as revenue in accordance with the Company's normal policy. (m) Research and Development Research and development costs are expensed as incurred. (n) Stock-based Compensation Plans The Company recognizes compensation costs for all stock-based awards based upon each award's estimated fair value as determined on the date of grant. The Company utilizes the Black-Scholes option-pricing model to determine the fair value of stock option awards. Compensation cost is recognized on a straight- line basis over the respective vesting period of the award. Adjustments for actual forfeitures are made in the period which they occur. (o) Advertising The Company expenses advertising costs as incurred. The Company incurred approximately $ 1,648 and $ 3,024 in advertising costs during the years ended December 31, 2019 and 2018, respectively. (p) Income Taxes The Company accounts for deferred income taxes using the asset and liability method. Under this method, deferred income taxes arise from temporary differences between the tax basis of assets and liabilities and their reported amounts in the financial statements, which will result in taxable or deductible amounts in the future. Temporary differences are then measured using the enacted tax rates and laws. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount that is more-likely than-not to be realized. Determining the appropriate amount of valuation allowance requires management to exercise judgment about future operations. In the ordinary course of business, there are many transactions for which the ultimate tax outcome is uncertain. The Company regularly assesses uncertain tax positions in each of the tax jurisdictions in which it has operations and accounts for the related consolidated financial statement implications. The amount of unrecognized tax benefits is adjusted when information becomes available or when an event occurs indicating a change is appropriate. The Company includes interest and penalties related to its uncertain tax positions as part of income tax expense. 60 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (q) Foreign Currency The Company is exposed to foreign currency exchange risk as foreign subsidiaries generally operate and utilize functional currencies in local currencies other than the U.S. Dollar, which is the Company's reporting currency. The Company translates foreign assets and liabilities at exchange rates in effect at the balance sheet dates, and the revenues and expenses using average rates during the year. The resulting foreign currency translation adjustments are recorded as a separate component of accumulated other comprehensive income in the accompanying consolidated balance sheets. The Company does not hedge foreign currency translation risk in the net assets and income it reports from these sources. Exchange rate fluctuations on short-term intercompany loans are included in other expense in the consolidated statement of operations and comprehensive loss. (r) Recent Accounting Pronouncements On January 1, 2020, the Company adopted the provision of ASU 2017-04, Intangibles - Goodwill and Other: Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). The guidance removes step two of the goodwill impairment test, which requires a hypothetical purchase price allocation. A goodwill impairment will now be the amount by which a reporting unit’s carrying value exceeds its fair value, not to exceed the carrying amount of goodwill. Entities will continue to have the option to perform a qualitative assessment to determine if a quantitative impairment test is necessary. (3) Concentrations Consolidated financial instruments that potentially subject the Company to a concentration of credit risk principally consist of cash and cash equivalents and accounts receivable. At December 31, 2019, the Company's cash and cash equivalents and restricted cash are held in deposit accounts at six different banks totaling $30,921. The Company has not experienced any losses in such accounts, and management does not believe the Company is exposed to any significant credit risk. Management further believes that credit risk in the Company's accounts receivable is substantially mitigated by the Company's evaluation process, relatively short collection terms, and the high level of creditworthiness of its customers. The Company continually monitors the compliance of its customers with the Company's payment terms, but generally requires no collateral. The Company had one customer representing approximately 15% of the Company's net accounts receivable balance as of December 31, 2019. There were no concentrations greater than 10% the Company's net accounts receivable as of December 31, 2018. The Company had no single customer that comprised more than 10% of the Company's total revenues for the years ended December 31, 2019 and 2018. (4) Inventory Inventory consists of the following as of December 31: Raw materials Work in progress Finished goods Total inventory 2019 2018 $ $ 2,834 $ 532 5,499 8,865 $ 3,806 352 5,774 9,932 The Company recorded an inventory impairment charge of $ 162 and $ 387 for the years ended December 31, 2019 and 2018, respectively. During the year ended December 31, 2019, the Company disposed of $157 of expired product. Finished goods included $ 147 of inventory on consignment at customer locations at December 31, 2019. 61 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (5) Property, Equipment and Right-of-Use Assets Property and equipment consists of the following as of December 31: Equipment Right-of-use assets Furniture, fixtures and tooling Computer hardware Leasehold improvements Construction in process Less accumulated depreciation Property, equipment and right-of-use assets Depreciable Lives 5 years 1 - 5 years 4 - 8 years 3 - 5 years 3 - 5 years 2019 2018 $ 7,491 $ 2,890 2,233 1,261 1,671 198 15,744 (9,132) $ 6,612 $ 7,510 — 2,223 1,326 1,400 130 12,589 (6,692) 5,897 The Company recorded depreciation expense of $ 1,859 and $ 2,024 for the years ended December 31, 2019 and 2018, respectively. There were no impairment charges for the years ended December 31, 2019 or 2018. The Company disposed of $412 of fully depreciated property, equipment and right-of-use assets no longer being utilized during the year ended December 31, 2019. As of December 31, 2019, the maturities of the Company's operating lease liabilities are as follows: 2020 2021 2022 2023 2024 Thereafter Total lease payments Less imputed interest Total operating lease liabilities $ 1,092 891 183 95 30 — 2,291 (243) 2,048 $ Operating lease liabilities of $ 932 and $ 1,116 are included in accrued expenses and long-term liabilities, respectively, as of December 31, 2019. Operating lease expense and cash paid within operating cash flows for operating leases was $1,233 and $ 1,290 during 2019 and 2018, respectively. The weighted average remaining lease term was 2.18 years and the weighted average discount rate used to estimate the value of the operating lease liabilities was 9.7%. (6) Goodwill and Other Intangible Assets The following table reflects the changes in goodwill for the years ended December 31, 2019 and 2018: December 31, 2017 Divestiture of Surgical product line December 31, 2018 December 31, 2019 $ $ $ 6,828 (1,538) 5,290 5,290 62 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Other intangible assets consist of the following as of December 31: Customer relationships Orbera technology Trade names Patents and trademarks Other Less accumulated amortization Intangible assets, net Useful Life 9 years 12 years 10 years 5 years 1 - 5 years 2019 2018 $ 8,301 $ 4,600 1,700 2,453 2,425 19,479 (11,648) $ 7,831 $ 8,301 4,600 1,700 2,292 2,421 19,314 (9,455) 9,859 Amortization expense related to the above intangible assets was $ 2,201 and $ 7,268 during 2019 and 2018, respectively. Additionally, $ 161 and $ 416 related to the extension and renewal of patents and trademarks was capitalized during 2019 and 2018, respectively. Amortization for the next five years is as follows: 2020 2021 2022 2023 2024 Thereafter Total (7) Other Assets $ $ 1,944 1,822 1,646 879 595 945 7,831 Included in other assets as of December 31, 2019 and 2018 was $ 2,511 and $ 3,921 for the non-current portion of the receivable due from ReShape, respectively. Interest on the receivable accretes 10% annually. Imputed interest income on the ReShape receivable was $ 619 for the year ended December 31, 2019 and is included within interest expense, net. (8) Accrued Expenses Accrued expenses consists of the following as of December 31: Accrued employee compensation and expenses Settlement liability Lease liability Accrued professional service fees Accrued interest Accrued insurance and taxes Accrued returns and rebates Other Total accrued expenses 2019 2018 $ $ 3,183 $ 1,625 932 653 467 271 216 1,091 8,438 $ 3,804 — — 2,983 100 625 331 1,313 9,156 In April 2019, the Company entered into a settlement agreement with Allergan, Inc. to resolve a dispute related to amounts charged for inventory purchases and transition services provided through 2016, after the Company's asset acquisition of the obesity intervention business in December 2013. The settlement agreement provided for a payment of $3,250 to completely discharge all remaining possibility for these charges. Payment was made in May 2019 for $ 1,625 and the remaining payment of $1,625, included in accrued expenses, is due in April 2020. The Company recognized a gain of $ 5,609 in 2019 as a result of this settlement agreement. 63 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (9) Long-Term Debt Long-term debt consists of the following as of December 31: Term loan facility Senior secured credit facility Payment-in-kind interest Discount on long-term debt Deferred financing costs Less current portion Long-term debt 2019 2018 35,000 $ — 517 — (1,068) (34,449) — 19,500 2,142 (175) (277) — — $ 21,190 $ $ In March 2019, the Company entered into a Term Loan Facility (the "Credit Agreement") with Solar Capital, Ltd. ("Solar") to borrow $ 35,000. The Credit Agreement matures on September 1, 2023, with principal payments beginning in March 2021, and bears interest at LIBOR plus 7.5%. In March 2020, the interest rate was amended to be equal to 7.5% plus the greater of (i) the one month LIBOR rate or an alternate rate agreed upon by both parties in the event the LIBOR rate is no longer available, or (ii) 1.35575%. Interest only is payable in arrears until March 1, 2021 (or July 1, 2021 if certain revenue milestones are achieved). Principal payments are due on a straight-line basis after the interest-only period concludes. An additional 4.9% of the outstanding amount will be due at end of the loan term and an additional 4.5% fee of the Term Loan funded amount will be due at the earlier of an Exit Event (as defined in the Credit Agreement) or if the Company achieves trailing twelve-month revenue of $100,000 before March 15, 2029. The Credit Agreement provides that the Company may borrow an additional $5,000 upon its request subject to further credit approval. The Credit Agreement includes the customary affirmative covenants, negative covenants and financial covenants, including a minimum liquidity requirement and minimum product revenues. The Company used $22,372 of the proceeds of the Credit Agreement to repay its previous senior secured credit agreement in full, including interest. Unamortized deferred financing costs and discount of $388 were written off in March 2019 in connection with the repayment. In June 2019, the Company entered into the First Amendment to the Credit Agreement which adjusted the trailing six-month Endoscopy revenue requirements for the periods ending June 30, July 31, and August 31, 2019 and increased the minimum liquidity covenant to $12,500. In August 2019, the Company entered into the Second Amendment to the Credit Agreement to allow for the issuance of up to $20,000 aggregate principal amount of 6.0% convertible senior debentures due 2024 (the "Convertible Debt"). In October 2019, the Company entered into the Third Amendment to the Credit Agreement that adjusted the trailing six-month Endoscopy revenue requirements for the periods ending August 31, 2019 through December 31, 2019. In March 2020, the Company entered into the Fourth Amendment and Limited Waiver to the Credit Agreement which established the 2020 revenue covenant requirements, provides an additional $10,000 of funding upon the achievement of these revenue requirements through June 2020, and waived the financial statement covenant default associated with the going concern opinion of our independent registered public accounting firm for the year ended December 31, 2019. See Note 19. Interest expense on the Company's long term debt was $ 4,579 and $ 4,488 for the years ended December 31, 2019 and 2018, respectively. The Company has classified its debt obligations with long-term contractual maturities as current liabilities at December 31, 2019 based on the Company's assessment that it may not be able to meet the debt covenant requirements included in the Credit Agreement for at least one year from the issuance of the Consolidated Financial Statements considering factors such as the uncertainties from the COVID-19 pandemic. The contractual terms of the agreement set out principal payments as follows: 2020 2021 2022 2023 2024 Thereafter Total $ $ — 11,667 14,000 9,333 — — 35,000 64 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (10) Convertible debt Convertible debt consists of the following as of December 31: Convertible debt principal Deferred financing costs Convertible debt 2019 2018 $ $ 20,000 $ (1,446) 18,554 $ — — — In August 2019, the Company issued $ 20,000 aggregate principal amount of Convertible Debt, primarily to existing stockholders and officers of the Company. Interest on the Convertible Debt will be payable semi-annually in shares of the Company's common stock on January 1 and July 1 of each year, at a rate of 6.0% per year. The number of shares of common stock required to settle the amount of interest payable will be based on the average volume-weighted average price ("VWAP") of the Company's common stock for the 10 consecutive trading days immediately preceding the applicable interest payment date. The Convertible Debt will mature on August 12, 2024 unless earlier converted or repurchased in accordance with its terms. In January 2020, the Company issued 164,797 shares of the Company's common stock to holders of the Convertible Debt in fulfillment of $ 467 of accrued interest as of December 31, 2019. The Convertible Debt converts, at the option of the holders, into shares of the Company's common stock at an initial conversion price of $ 3.25 per share, subject to adjustment. If the VWAP of the Company's common stock has been at least $9.75 (subject to adjustment) for at least 20 trading days during any 30 consecutive trading day period, the Company may force the conversion of all or any part of the outstanding principal amount of the Convertible Debt, accrued and unpaid interest and any other amounts then owing, subject to certain conditions. Interest expense on the Convertible Debt was $ 588 for the year ended December 31, 2019. (11) Stockholders' Equity (a) Authorized Stock The Company’s amended and restated certificate of incorporation, authorizes the Company to issue 115,000,000 shares of common and preferred stock, consisting of 100,000,000 shares of common stock with $0.001 par value and 15,000,000 shares of preferred stock with $0.001 par value. The Company has reserved common shares for issuance upon the exercise of the authorized and issued common stock options and warrants. (b) Warrants Warrants consist of the following as of December 31, 2019: Warrant Expiration Date December 29, 2021 February 27, 2022 No expiration Total number of warrants outstanding Weighted average exercise price of warrants outstanding Number of shares Exercise price per share 40,456 $ 163,915 $ 1,000,000 $ 1,204,371 $ 13.70 21.29 0.001 3.36 There were no warrants exercised in 2019 and 46,818 expired during the year ended December 31, 2019. In August 2019, the Company issued a pre-funded warrant ("Warrant"), to exchange up to 1,000,000 shares of the Company's common stock, at an exercise price of $0.001 per share, to an existing stockholder for 1,000,000 shares of common stock held by such stockholder. The common stock received in the exchange was subsequently retired. The Warrant may be exercised at any time until the Warrant is exercised in full. The holder (together with its affiliates) may not exercise any portion of the Warrant to the extent that the holder would beneficially own more than 9.99% of the outstanding common stock in the aggregate immediately after exercise. 65 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (12) Stock Option Plans (a) Plans 2006 Plan The Company's 2006 Equity Incentive Plan (the "2006 Plan") covers employees, consultants, and nonemployee directors of the Company and provides for the grant of incentive stock options or nonqualified stock options to purchase shares of the Company's common stock. Options to date have been granted to employees at 100% of the fair value at the date of the grant. The fair value, vesting period, and expiration dates of the options granted were determined by the Board of Directors at the time of grant. The maximum term of options granted under the 2006 Plan is 10 years from the date of grant. Options generally vest over a period of time, typically not more than 5 years. Under certain circumstances, the Company may repurchase previously granted options or shares issued upon the exercise of a previously granted option. The 2006 Plan expired in May 2016. 2016 Plan The Company's 2016 Equity Incentive Plan (the "2016 Plan") covers employees, consultants, and nonemployee directors of the Company and provides for the grant of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock awards, restricted stock units and other stock awards to purchase shares of the Company's common stock. Options to date have been granted to employees at 100% of the fair value at the date of the grant. The fair value, vesting period, and expiration dates of the options granted are determined by the Board of Directors at the time of grant. The maximum term of options granted under the 2016 Plan is 10 years from the date of grant. Options generally vest over a period of time, typically not more than 5 years. The 2016 Plan was replaced by the 2017 Plan. 2017 Plan The Company's 2017 Equity Incentive Plan (the "2017 Plan") was approved in June 2017 by the Company's stockholders. The 2017 plan covers employees, consultants, and nonemployee directors of the Company and provides for the grant of incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock awards, restricted stock units, performance stock awards, performance cash awards, and other stock awards to purchase shares of the Company's common stock. Options to date have been granted to employees at 100% of the fair value at the date of the grant. The fair value, vesting period, and expiration dates of the options granted are determined by the Board of Directors at the time of grant. The maximum term of options granted under the 2017 Plan is 10 years from the date of grant. Options generally vest over a period of time, typically not more than 5 years. The plan's reserve is automatically increased by 4% of the total number of shares outstanding at the prior year end for a period of ten years. Shares subject to awards granted under the 2017 Plan which expire, are repurchased, or are canceled or forfeited will again become available for issuance under the 2017 Plan. The shares available will not be reduced by awards settled in cash or by shares withheld to satisfy tax withholding obligations. Only the net number of shares issued upon the exercise of stock appreciation rights or options exercised by means of a net exercise will be deducted from the shares available under the 2017 Plan. The 2017 Plan replaced the Company's 2016 Plan, which was the successor to the 2006 Plan, and the Lpath Plan (collectively, the Lpath Plan, with the 2016 Plan and the 2006 Plan, the "Prior Plans"). Grants will no longer be made under the Prior Plans, but the awards that remain outstanding will continue to be governed by the terms of the applicable Prior Plan and the applicable award agreement. As of December 31, 2019, the Company has 1,150,189 shares of common stock reserved for issuance under the 2017 Plan. 66 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (b) Stock Option Activity A summary of the stock option activity under the Company's 2017 Plan and Prior Plans (collectively, the "Equity Plans") as of December 31, 2019 is presented below. Options outstanding, December 31, 2018 Options granted Options exercised Options forfeited Options outstanding, vested and expected to vest, December 31, 2019 Options exercisable Options Weighted Average Exercise Price 1,502,756 781,705 (17,158) (340,109) 1,927,194 1,006,635 $5.63 $3.47 $1.83 $4.35 $5.01 $5.24 Weighted Average Remaining Contractual Term Aggregate Intrinsic Value 7.7 years $217 7.5 years 6.3 years $87 $83 The fair value for options under the Equity Plans was estimated at the date of grant using the Black-Scholes option pricing model in valuing the stock awards. Prior to December 2016, the value of the Company's common stock was determined by an independent valuation firm using a blend of an income approach, market approach and cost approach. The Black-Scholes model requires estimating dividend yield, volatility, risk-free rate of return during the service period and the expected term of the award. The expected dividend yield assumption is based on the Company’s expectation of zero future dividend payouts. The volatility assumption is based on the historical volatilities of the Company’s common stock and of comparable public companies. The risk free rate of return assumption utilizes yields on U.S. treasury zero-coupon bonds with maturity that is commensurate with the expected term for awards issued to employees and the contractual term for awards issued to non-employees. The expected term is derived using the simplified method and represents the weighted average period that the stock awards are expected to remain outstanding. The fair value of stock option grants has been estimated at the date of grant using the Black-Scholes option pricing model with the following weighted average assumptions for the years ended December 31: Risk free interest rate Expected dividend yield Estimated volatility Expected life Additional information regarding options is as follows: Stock compensation cost Weighted-average grant date fair value of options granted during the period Aggregate intrinsic value of options exercised during the period 2019 2.2% —% 64.6% 6.0 years 2018 2.7% —% 63.3% 5.8 years 2019 2018 $ $ $ 1,487 $ 2.08 $ 20 $ 1,403 3.95 921 The aggregate intrinsic value in the table above represents the total pre-tax value of the options shown, calculated as the difference between the Company’s closing stock price on December 31, 2019 and the exercise prices of the options shown, multiplied by the number of in-the money options. This is the aggregate amount that would have been received by the option holders if they had all exercised their options on December 31, 2019 and sold the shares thereby received at the closing price of the Company’s stock on that date. This amount changes based on the closing price of the Company’s stock. Annually the Company grants options to its sales and marketing personnel that begin to time vest only upon the individual's achievement of a certain revenue target. In 2019, 64,692 options were determined to have met the underlying conditions. The remaining performance shares were unearned and forfeited. Unrecognized compensation expense related to unvested options was approximately $ 2,342 at December 31, 2019, with a remaining amortization period of less than 2.4 years. 67 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. A summary of the restricted stock unit activity under the Company's Equity Plans as of December 31, 2019 is presented below: Unvested units, December 31, 2018 Restricted stock units granted Restricted stock units vested Restricted stock units forfeited Unvested units, December 31, 2019 Units 94,940 200,009 (35,283) (15,971) 243,695 Weighted Average Grant Date Fair Value Aggregate Intrinsic Value $6.21 $3.46 $6.30 $4.37 $4.06 $328 $695 Unrecognized compensation expense related to unvested restricted stock units was approximately $ 780 at December 31, 2019, with a remaining amortization period of 2.8 years. (13) Commitments (a) Risk Management The Company maintains various forms of insurance that the Company's management believes are adequate to reduce the exposure to these risks to an acceptable level. (b) Employment Agreements Certain executive officers are entitled to payments if they are terminated without cause or as a result of a change in control. Upon termination without cause, and not as a result of death or disability, each of such officers is entitled to receive a payment of base salary for three to twenty-four months following termination of employment and such officer will be entitled to continue to receive coverage under medical and dental benefit plans for three to twelve months or until such officer is covered under a separate plan from another employer. Upon a termination other than for cause or for good reason within twelve months following a change in control, each of such officers will be entitled to the same benefits as upon termination without cause and will also be entitled to certain acceleration of such officer's outstanding unvested options at the time of such termination. (c) Litigation Management believes there are no claims or actions pending or threatened against the Company, the ultimate disposition of which would have a material impact on the Company's consolidated financial position, results of operations or cash flows. (d) Purchase Commitments In February 2020, the Company entered into a one-year noncancellable purchase agreement to purchase $ 531 of raw materials in the normal course of business. (14) Defined Contribution Plan The Company sponsors defined contribution plans for employees in the U.S. and Europe. The cost of these plans, including employer contributions, was $698 and $ 731 for the years ended December 31, 2019 and 2018 respectively. 68 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. (15) Income Taxes Income tax expense of $ 275 and $ 191 for the years ended December 31, 2019 and 2018, respectively is composed of foreign income taxes on earnings generated by foreign subsidiaries. Deferred income taxes reflect the net effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of the Company's deferred taxes at December 31 are as follows: 2019 2018 Deferred tax assets: Capitalized transaction costs Intangible assets Inventory valuation Research and development credit Interest expense carryforward Foreign timing differences Other Net operating loss carryforwards Deferred tax liabilities: Unremitted foreign earnings Depreciable assets Total net deferred tax assets Less valuation allowance $ 330 $ 1,105 242 4,055 2,188 238 873 50,702 59,733 (453) (185) (638) 59,095 (59,049) Net deferred tax assets (included in other assets) $ 46 $ 385 1,321 255 3,597 1,034 187 908 45,067 52,754 (461) (64) (525) 52,229 (52,229) — The Company has established a valuation allowance due to uncertainties regarding the realization of deferred tax assets based on the Company's lack of earnings history and potential limitations pursuant to changes in ownership under Internal Revenue Code Section 382. The valuation allowance increased by $6,820 during the year ended December 31, 2019, primarily as a result of changes in net operating loss. As of December 31, 2019, the Company has no unrecognized tax benefits or accrued interest or penalties associated with uncertain tax positions. The Company's provision for income taxes differs from the expected tax expense amount computed by applying the statutory federal income tax rate of 21% to income before income taxes as a result of the following: Tax at U.S. statutory rate State taxes, net of deferred benefit Foreign tax rate differential Foreign taxes Permanent differences Research and development tax credit Other Deferred tax adjustment Unremitted foreign earnings Valuation allowance - current year Income tax expense 2019 2018 (5,703) $ (1,051) (330) 22 442 (408) 478 (1) 6 6,820 275 $ (9,575) (2,017) (92) (88) 993 (362) 211 796 13 10,312 191 $ $ 69 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. As of December 31, 2019, the Company had federal net operating loss carryforwards of approximately $ 209,666 which will expire in varying amounts beginning in 2025 if not utilized. The Company’s July 2017 stock offering qualified as an ownership change under section 382 which resulted in a reduction of $100,825 in the Company’s U.S. federal net operating losses that will not be utilizable in the future, thus federal net operating loss carryforwards available to the Company as of December 31, 2019 were $108,841. In August 2019, the Company consummated a convertible debt issuance that could potentially have triggered an additional ownership change and is still being assessed. The deferred tax asset associated with net operating loss carryforwards has been offset by a valuation allowance due to the uncertainty that the Company will achieve taxable income necessary to utilize the net operating loss carryforward in the future. The Company had state net operating loss carryforwards of approximately $ 107,013 which will begin to expire in varying amounts beginning in 2020, if not utilized. The Company had foreign net operating losses of approximately $2,803 which begin to expire in varying amounts beginning in 2020, if not utilized. (16) Medical Device Excise Tax Effective as of January 1, 2013, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act, imposed a medical device excise tax (MDET) of 2.3% on any entity that manufactures or imports certain medical devices offered for sale in the U.S. In December 2015, the medical device tax was suspended for two years and on January 22, 2018 the moratorium on this tax was extended through December 31, 2019. On December 20, 2019, the medical device tax was repealed. (17) Net Loss Per Share The basic and diluted net loss per common share presented in the consolidated statement of operations and comprehensive loss is calculated by dividing net loss by the weighted-average number of common shares outstanding during the period, without consideration for common stock equivalents. Potentially dilutive shares, which include warrants for the purchase of common stock, convertible debt, restricted stock units, and options outstanding under the Company's equity incentive plans, are considered to be common stock equivalents and are only included in the calculation of diluted net loss per share when their effect is dilutive. Potentially dilutive securities not included in the calculation of diluted net loss per share attributable to common stockholders because to do so would be anti- dilutive are as follows (in common stock equivalent shares on a weighted average basis): Warrants for common stock Convertible debt Common stock options Restricted stock units Year Ended December 31 2019 2018 590,672 2,440,904 1,699,410 169,808 4,900,794 251,189 — 1,382,512 84,183 1,717,884 (18) Segment and Geographic Information Operating segments are defined as components of an enterprise for which separate financial information is available and evaluated regularly by the chief operating decision maker, or decision-making group, in deciding how to allocate resources and in assessing performance. The Company globally manages the business within one reportable segment. Segment information is consistent with how management reviews the business, makes investing and resource allocation decisions and assesses operating performance. Product sales by product group and geographic market, based on the location of the customer, whether the U.S. or outside the U.S. ("OUS") for the periods shown were as follows: 70 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. ESS IGB Total Endoscopy Surgical Other Total revenues % Total revenues Year Ended December 31, 2019 Year Ended December 31, 2018 U.S. OUS Total Revenues % Total Revenues U.S. OUS Total Revenues % Total Revenues $ 14,944 $ 13,365 $ 28,309 55.8 % $ 11,016 $ 12,364 $ 23,380 5,162 20,106 — 1,815 11,678 25,043 3,712 37 16,840 45,149 3,712 1,852 33.2 % 89.0 % 7.3 % 3.7 % 5,400 16,416 10,795 995 12,339 24,703 7,913 32 17,739 41,119 18,708 1,027 38.4 % 29.2 % 67.6 % 30.7 % 1.7 % $ 21,921 $ 28,792 $ 50,713 100.0 % $ 28,206 $ 32,648 $ 60,854 100.0 % 43.2 % 56.8 % 46.4 % 53.6 % Total distributor sales were 33.9% and 24.8% of total OUS revenues for the years ended December 31, 2019 and 2018, respectively. Sales in the next largest individual country outside the U.S. were 7.6% for both the years ended December 31, 2019 and 2018. The following table represents property, equipment and right-of-use assets based on the physical location of the asset: U.S. Costa Rica Other Total property, equipment and right-of-use assets (19) Subsequent Events 2019 2018 $ $ 2,934 $ 3,039 639 6,612 $ 2,337 3,347 213 5,897 In March 2020, the Company entered into the Fourth Amendment and Limited Waiver to the Credit Agreement which (i) established the trailing six-month Endoscopy revenue requirements for 2020, (ii) provides an additional $10,000 of funding to be drawn in July 2020 upon the achievement of the established revenue requirements through June 2020, which is repayable in April 2021 in the event that the trailing six-month Endoscopy revenue requirements for the period ending December 31, 2020 is less than $26,900, (iii) extended the interest-only period until July 1, 2021, if certain revenue milestones are achieved, (iv) requires the Company to raise additional cash of $15,000 from debt or equity financing by August 2020, (v) established a minimum LIBOR interest rate, and (vi) waived the financial statement covenant default associated with the going concern opinion by the Company's independent registered public accounting firm for the year ended December 31, 2019. The Credit Agreement provides that we may borrow an additional $5.0 million upon our request, subject to further credit approval. On March 10, 2020, the World Health Organization declared the COVID-19 outbreak a pandemic, and on March 13, 2020, the President of the United States declared the COVID-19 pandemic a national emergency, invoking powers under the Stafford Act, the legislation that directs federal emergency disaster response. We continue to monitor our operations and government mandates and the disruptions that COVID-19 will have on our business, operating results and financial condition. 71 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None ITEM 9A. CONTROLS AND PROCEDURES Evaluation of Disclosure Controls and Procedures Our management evaluated, with the participation and under the supervision of our Chief Executive Officer and our Chief Financial Officer, the effectiveness and design and operation of our disclosure controls and procedures (as defined in Rule 13a-15(e) of the Securities Exchange Act of 1934, as amended, or the Exchange Act) as of the end of the period covered by this Annual Report on Form 10-K. Based on this evaluation, our Chief Executive Officer and our Chief Financial Officer have concluded that as of December 31, 2019 our disclosure controls and procedures were effective at a reasonable assurance level. Management’s Report on Internal Control over Financial Reporting Our management is responsible for establishing and maintaining adequate internal control over financial reporting (as defined in Rule 13a-15(f) of the Exchange Act). Our management, including our Chief Executive Officer and Chief Financial Officer and oversight of our Board of Directors, conducted an evaluation of the effectiveness of our internal control over financial reporting as of December 31, 2019 based on the framework in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organization of the Treadway Commission ("COSO"). Based on our evaluation under the criteria set forth in Internal Control — Integrated Framework, our management concluded that our internal control over financial reporting was effective as of December 31, 2019. Attestation Report of the Registered Public Accounting Firm This Annual Report on Form 10-K does not include an attestation report of our independent registered public accounting firm regarding internal control over financial reporting. Since we are a smaller reporting company and a non-accelerated filer, the rules of the Securities and Exchange Commission permits us to provide only management's report on internal controls over financial reporting in this Annual Report on Form 10-K. Previously Disclosed Material Weakness In our Annual Report on Form 10-K for the period ended December 31, 2018, management identified a material weakness in our internal control over financial reporting. A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The material weakness was due to an aggregation of control deficiencies over the verification of sales orders including price change approvals, the approval of credit memos and the verification of the application of cash to individual customer account balances that were identified during our transition of the sales order process during the fourth quarter of 2018 from a third party service provider to our internal organization. This material weakness did not result in any adjustments to our consolidated financial statements. Remediation of Previously Disclosed Material Weakness We have implemented additional controls during 2019 to address the deficiencies identified in our sales order to cash process. Based on the additional controls implemented and our evaluation of the effectiveness of these controls, management has concluded that the material weakness described above and first disclosed in our Annual Report on Form 10-K for the year ended December 31, 2018 has been remediated as of December 31, 2019. Changes in Internal Control Over Financial Reporting There have been no other changes in our internal control over financial reporting that occurred during the year ended December 31, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting, other than as described above under "Remediation of Previously Disclosed Material Weakness". 72 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Inherent Limitations on Effectiveness of Controls Our management, including our principal executive and principal financial officers, does not expect that our disclosure controls and procedures or our internal controls, will prevent all error and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within Apollo have been detected. ITEM 9B. OTHER INFORMATION COVID-19 Salary and Bonus Actions The global outbreak of COVID-19 continues to rapidly evolve. The ultimate impact of the COVID-19 outbreak is highly uncertain and subject to change. We cannot accurately predict the full extent of potential delays or impacts on our sales, results of operations, clinical trials related to our products, healthcare systems or the global economy as a whole or to our business. In March 2020, in response to the COVID-19 pandemic, we took steps to reduce 2019 employee bonus payments and implemented a temporary reduction in employee salary and work hours, where practical, to mitigate the anticipated reduction in business activity. The duration of the temporary reduction in employee salary and work hours is indefinite. We previously announced in a Current Report on Form 8-K filed on March 5, 2020 the 2020 base salary levels for our executive officers, including our named executive officers. In addition, we previously announced in a Current Report on Form 8-K filed on March 5, 2019 the 2019 target performance bonus levels for our executive officers under our 2019 bonus plan. The executive officers' reduced 2020 base salary and 2019 bonus payments are as follows: Name and Principal Position Todd Newton Chief Executive Officer Stefanie Cavanaugh Chief Financial Officer Christopher J. Gostout, M.D. Chief Medical Officer Bret Schwartzhoff Vice President, North America Sales and Global Marketing John Molesphini Executive Vice President, Operations Final 2019 Bonus Reduced 2020 Base Salary $ — $ 282,907 13,083 197,785 8,822 155,599 15,054 199,133 11,377 193,479 The information required by Part III is omitted from this report because we will file a definitive proxy statement within 120 days after the end of our 2019 fiscal year pursuant to Regulation 14A for our 2020 Annual Meeting of Stockholders, (the "2020 Proxy Statement") and the information to be included in the 2020 Proxy Statement is incorporated by reference. PART III ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE The information required by this Item will be included in our 2020 Proxy Statement and is incorporated herein by reference. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item will be included in our 2020 Proxy Statement and is incorporated herein by reference. 73 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS The information required by this Item will be included in our 2020 Proxy Statement and is incorporated herein by reference. ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE The information required by this Item will be included in our 2020 Proxy Statement and is incorporated herein by reference. ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES The information required by this Item will be included in our 2020 Proxy Statement and is incorporated herein by reference. 74 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES a. Financial Statements and Financial Statement Schedules i. Financial Statements PART IV The financial statements of Apollo Endosurgery, Inc. listed below are set forth in Item 8 of this report for the year ended December 31, 2019: Report of Independent Registered Public Accounting Firm Consolidated Balance Sheets Consolidated Statements of Operations and Comprehensive Loss Consolidated Statements of Changes in Redeemable Preferred Stock and Stockholders' Equity Consolidated Statements of Cash Flows Notes to Consolidated Financial Statements 52 53 54 55 56 57 ii. Financial Statement Schedules All other schedules are omitted because they are not applicable or the required information is shown in the financial statements or notes thereto. b. Exhibits Description of Document Schedule / Form File Number Exhibit Filing Date Incorporated by Reference Agreement and Plan of Merger and Reorganization, dated as of September 8, 2016, by and among Lpath, Inc., Lpath Merger Sub, Inc., and Apollo Endosurgery, Inc. Asset Purchase Agreement, dated December 17, 2018, by and between Apollo Endosurgery, Inc. and ReShape Lifesciences Inc. Amended and Restated Certificate of Incorporation Amended and Restated Bylaws Form of Common Stock Certificate of the registrant Form of Warrant Issued to Investors in the September 2014 Offering Form of Warrant issued to Torreya Capital Apollo Common Stock Purchase Warrant issued to Athyrium Opportunities II Acquisition LP dated February 27, 2015 Third Amended and Restated Investors' Rights Agreement, dated as of September 8, 2016 by and among Apollo Endosurgery, Inc. and the investors listed on Exhibit A thereto Form of 6.0% Convertible Debenture due 2024 Description of Securities 2020 Bonus Plan 8-K 8-K 8-K 8-K 10-Q 8-K S-4 S-4 S-4 8-K 8-K 75 001-35706 001-35706 001-35706 001-35706 001-35706 001-35706 333-214059 333-214059 333-214059 001-35706 2.1 2.1 3.1 3.2 4.1 4.1 4.7 4.8 4.9 4.1 September 8, 2016 December 19, 2018 June 13, 2017 June 13, 2017 May 4, 2017 September 22, 2014 October 11, 2016 October 11, 2016 October 11, 2016 August 16, 2019 001-35706 10.1 March 5, 2020 Exhibit Number 2.1++ 2.2++ 3.1 3.2 4.1 4.2 4.3 4.4 4.5 4.6 4.7 * 10.1# EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Description of Document Schedule / Form File Number Exhibit Filing Date Incorporated by Reference 333-214059 001-35706 001-35706 001-35706 001-35706 001-35706 001-35706 001-35706 001-35706 001-35706 001-35706 001-35706 10.18 10.11 10.2 10.1 10.2 10.3 10.5 10.6 10.1 10.5 10.1 10.4 October 11, 2018 March 1, 2018 May 3, 2018 May 30, 2018 May 30, 2018 May 30, 2018 August 8, 2018 August 8, 2018 March 18, 2019 August 16, 2019 October 30, 2019 August 8, 2018 331-214059 10.20 October 11, 2016 331-214059 10.21 November 14, 2016 001-35706 001-35706 001-35706 10.1 10.2 10.3 June 13, 2017 June 13, 2017 June 13, 2017 S-4 10-K 10-Q 8-K 8-K 8-K 10-Q 10-Q 10-K 8-K 10-Q 10-Q S-4 S-4 8-K 8-K 8-K 76 Exhibit Number 10.2# 10.3# 10.4# 10.5# 10.6# 10.7# 10.8# 10.9# 10.10 Offer Letter, dated November 19, 2014, between Apollo Endosurgery, Inc. and Bret Schwartzhoff Gostout offer letter, dated December 9, 2016 John Molesphini Offer Letter Form of Change in Control Agreement Second Amendment to Employment Agreement dated June 1, 2014 by and between the Company and Todd Newton First Amendment to Employment Agreement dated March 2, 2015 by and between the Company and Stefanie Cavanaugh Non-Employee Director Compensation Policy May 2018 amendment Form of Indemnification Agreement Loan and Security Agreement, dated March 15, 2019, by and among the Company, Solar Capital, Ltd, the guarantors party thereto, and the lenders. 10.11 Second Amendment, dated August 7, 2019, to the Loan and Security Agreement, dated March 15, 2019, by and among Apollo Endosurgery, Inc., Solar Capital, Ltd., the guarantors party thereto, and the lenders. Third Amendment to Loan and Security Agreement, Waiver and First Amendment to Fee Letter First Amendment to Office Lease Agreement dated June 11, 2018, by and between the Company and DPF Cityview LP Lease Agreement, dated August 7, 2014, between Apollo Endosurgery Costa Rica Sociedad de Responsabilidad Limitada and Zona Franca Coyol, S.A. Intellectual Property Assignment Agreement, dated November 4, 2009, by and between Apollo Endosurgery, Inc., Olympus Corporation, the University of Texas Medical Branch, the Johns Hopkins University, the Mayo Foundation for Medical Education and Research, the Medical University of South Carolina Foundation for Research Development and the Chinese University of Hong Kong. Apollo Endosurgery, Inc. 2017 Equity Incentive Plan Forms of grant notice, stock option agreement and notice of exercise under the Apollo Endosurgery, Inc. 2017 Equity Incentive Plan Form of restricted stock unit grant notice and award agreement under the Apollo Endosurgery, Inc. 2017 Equity Incentive Plan 10.12 10.13 10.14 10.15 10.16# 10.17# 10.18# EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Exhibit Number 10.19# 10.20# 10.21++ 10.22 10.23 10.24 21.1 23.1 * 31.1 * 31.2 * 32.1 * † 32.2 * † 101.INS* 101.SCH* 101.CAL* Description of Document Schedule / Form File Number Exhibit Filing Date Incorporated by Reference S-4 S-4 8-K 8-K 8-K 8-K S-4 333-214059 333-214059 001-35706 001-35706 001-35706 001-35706 333-214059 10.2 10.1 10.1 10.2 10.3 10.4 21.1 October 11, 2016 October 11, 2016 August 16, 2019 August 16, 2019 August 16, 2019 August 16, 2019 October 11, 2016 Apollo Endosurgery, Inc. 2016 Equity Incentive Plan and forms of agreements relating thereto Apollo Endosurgery, Inc. 2006 Stock Option Plan and forms of agreements relating thereto Securities Purchase Agreement, dated as of August 7, 2019, by and among Apollo Endosurgery, Inc. and the purchasers named therein. Registration Rights Agreement, dated as of August 7, 2019, by and among Apollo Endosurgery, Inc. and the purchasers named therein. Subsidiary Guarantee, dated as of August 12, 2019, issued by Apollo Endosurgery International, LLC, Apollo Endosurgery Costa Rica S.R.L., Apollo Endosurgery US, Inc., Lpath Therapeutics Inc. and Apollo Endosurgery UK Ltd. Pre-funded Warrant, dated as of August 12, 2019, issued by Apollo Endosurgery, Inc. List of Subsidiaries Consent of KPMG LLP, Independent Public Accounting Firm to Apollo Endosurgery, Inc. Certification of Chief Executive Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934 Certification of Chief Financial Officer as required by Rule 13a-14(a) of the Securities Exchange Act of 1934 Certification of Chief Executive Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934 Certification of Chief Financial Officer as required by Rule 13a-14(b) of the Securities Exchange Act of 1934 XBRL Instance Document XBRL Taxonomy Extension Schema Document XBRL Taxonomy Extension Calculation Linkbase Document 101.DEF* XBRL Taxonomy Extension Definition Linkbase Document 101.LAB* XBRL Taxonomy Extension Label Linkbase Document 101.PRE* XBRL Taxonomy Extension Presentation Linkbase Document ____________ # Management contract or compensation plan or arrangement * Provided herewith. 77 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. † In accordance with Item 601(b)(32)(ii) of Regulation S-K and SEC Release Nos. 33-8238 and 34-47986, Final Rule: Management's Reports on Internal Control Over Financial Reporting and Certification of Disclosure in Exchange Act Periodic Reports, the certifications furnished in Exhibits 32.1 and 32.2 hereto are deemed to accompany this Annual Report on Form 10-K and will not be deemed “filed” for purpose of Section 18 of the Exchange Act. Such certifications will not be deemed to be incorporated by reference into any filing under the Securities Act or the Exchange Act, except to the extent that the registrant specifically incorporates it by reference. + + Pursuant to Item 601 of Regulation S-K, the schedules to the applicable exhibit (identified therein) have been omitted from this report and will be furnished supplementally to the SEC upon request. ITEM 16. FORM 10-K SUMMARY None. 78 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. In accordance with the requirements of Section 13 on 15(k) of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf on March 26, 2020 by the undersigned thereto. SIGNATURES APOLLO ENDOSURGERY, INC. /s/ Todd Newton Todd Newton Chief Executive Officer KNOW ALL PERSONS BY THESE PRESENTS, that each person whose signature appears below constitutes and appoints Todd Newton and Stefanie Cavanaugh, jointly and severally, his or her attorneys-in-fact, each with the power of substitution, for him or her in any and all capacities, to sign any amendments to this report, and to file the same, with exhibits thereto and other documents in connection therewith with the Securities and Exchange Commission, hereby ratifying and confirming all that each of said attorneys-in-fact, or his or her substitute or substitutes may do or cause to be done by virtue hereof. In accordance with the requirements of the Securities Exchange Act of 1934, the registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized, on March 26, 2020. Signature Title Date /s/ Todd Newton Todd Newton /s/ Stefanie Cavanaugh Stefanie Cavanaugh /s/ Chrissy Citzler-Carr Chrissy Citzler-Carr /s/ John Barr John Barr /s/ Rick Anderson Rick Anderson /s/ Matthew S. Crawford Matthew S. Crawford /s/ Julie Shimer Julie Shimer /s/ William D. McClellan, Jr. William D. McClellan, Jr. Chief Executive Officer and Director (Principal Executive Officer) Chief Financial Officer, Treasurer and Secretary (Principal Financial Officer) Controller (Principal Accounting Officer) March 26, 2020 March 26, 2020 March 26, 2020 Chairman of the Board March 26, 2020 Director Director Director Director 79 March 26, 2020 March 26, 2020 March 26, 2020 March 26, 2020 EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. /s/ R. Kent McGaughy, Jr. R. Kent McGaughy, Jr. /s/ David C. Pacitti David C. Pacitti /s/ Bruce Robertson, PH.D. Bruce Robertson, Ph.D. Director Director Director 80 March 26, 2020 March 26, 2020 March 26, 2020 Exhibit 4.7 DESCRIPTION OF THE REGISTRANT’S SECURITIES REGISTERED PURSUANT TO SECTION 12 OF THE SECURITIES EXCHANGE ACT OF 1934 Apollo Endosurgery, Inc. (“we,” “our,” “us,” or the “Company”) has one class of securities registered under Section 12 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”): our common stock. General The following summary of the terms of our common stock is based upon our amended and restated certificate of incorporation and our amended and restated bylaws. This summary does not purport to be complete and is subject to, and is qualified in its entirety by express reference to, the applicable provisions of our amended and restated certificate of incorporation and our amended and restated bylaws, which are filed as exhibits to our Annual Report on Form 10-K, of which this Exhibit 4.7 is a part, and are incorporated by reference herein. We encourage you to read our amended and restated certificate of incorporation, our amended and restated bylaws, and the applicable provisions of the Delaware General Corporation Law, or the DGCL, for more information. We have authorized capital stock of up to (i) 100,000,000 shares of common stock, par value $0.001 per share and (ii) 15,000,000 shares of preferred stock. As of February 28, 2020, there were 21,116,760 shares of common stock issued and outstanding, which shares were held by 104 stockholders of record, and no shares of preferred stock outstanding. Common Stock All outstanding shares of our common stock are fully paid and nonassessable. Voting Rights Holders of our common stock are entitled to one vote for each share on all matters submitted to a stockholder vote, except matters that relate only to a series of preferred stock. In general, stockholder action (except for certain bylaw amendments and certain amendments to our amended and restated certificate of incorporation, which requires the affirmative vote of at least two-thirds of the shares entitled to vote) is based on the affirmative vote of holders of a majority of the shares of common stock represented either in person or by proxy and entitled to vote on such action. Directors are elected by majority vote, unless there is a contested election in which case the bylaws provide for plurality voting. Dividends Subject to limitations under Delaware law and preferences that may apply to any then-outstanding shares of preferred stock, holders of our common stock are entitled to share ratably in dividends, if any, as may be declared from time to time by the board of directors in its discretion from funds legally available therefor. Dividends, if any, will be contingent upon revenues and earnings, if any, and capital requirements and financial conditions. The payment of dividends, if any, will be within the discretion of the board of directors. We presently intend to retain all earnings, if any, and accordingly the board of directors does not anticipate declaring any dividends. Liquidation In the event of a liquidation, dissolution or winding up, the holders of common stock are entitled to share pro rata all assets remaining after payment in full of all liabilities and after providing for each class of stock, if any, having preference over the common stock, subject to the liquidation preference of any then outstanding shares of preferred stock. Miscellaneous Holders of common stock have no pre-emptive rights, no conversion rights and there are no redemption provisions applicable to the common stock. Preferred Stock Our preferred stock, par value $0.001 per share, may be issued from time to time in one or more series pursuant to a resolution or resolutions providing for such issue duly adopted by the board of directors (authority to do so being hereby expressly vested in our board of directors). The issuance of preferred stock may delay, deter or prevent a change in control. The EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. description of preferred stock above is not complete. You should refer to any applicable certificate of designation for complete information. Advanced Notice Requirement Our bylaws contain advance notice requirements for business to be brought before an annual or special meeting of stockholders, including nominations of persons for election as directors. As a result, stockholders must satisfy specific timing and information requirements in order to have a proposal considered at or in order to nominate a person for election as a director at an annual or special meeting. Any proposal or nomination that fails to comply with these timing and information requirements may be disqualified. No Cumulative Voting Our amended and restated certificate of incorporation does not include a provision for cumulative voting for directors. Authorized but Unissued Shares The authorized but unissued shares our common stock and preferred stock will be available for future issuance without stockholder approval. We may use additional shares for a variety of purposes, including future public offerings to raise additional capital, to fund acquisitions and as employee compensation. The existence of authorized but unissued shares of common stock and preferred stock could render more difficult or discourage an attempt to obtain control by means of a proxy contest, tender offer, merger or otherwise. Size of Board and Vacancies Our amended and restated bylaws provide that the number of directors on the board of directors is fixed exclusively by the board of directors. Newly created directorships resulting from any increase in the authorized number of directors or any vacancies in the board of directors resulting from death, resignation or other cause (including removal from office by a vote of the stockholders) may be filled only by (i) a majority vote of the directors based on the total number of designated directors, though less than a quorum, or by the sole remaining director or (ii) the stockholders holding a majority of the voting power of all of the then outstanding shares of capital stock of our company authorized by law or by the charter to vote on such action at a duly called annual meeting or a duly called special meeting of stockholders (including the special election meeting discussed below). The directors so chosen shall hold office for a term expiring at the next annual meeting of stockholders, and until their respective successors are elected, except in the case of the death, incapacity, resignation or removal of any director. Amendments of Governance Documents Our amended and restated certificate of incorporation and amended and restated bylaws provide that the affirmative vote of the holders of at least 66 2/3% of the voting stock then outstanding is required to amend certain provisions relating to the number, term, election and removal of its directors, the filling of its board vacancies, stockholder notice procedures, the calling of special meetings of stockholders, stockholders ability to act by written consent, and the indemnification of directors. Limitations on Liability, Indemnification of Officers and Directors and Insurance Our amended and restated certificate of incorporation includes provisions that require us to indemnify, to the fullest extent allowable under the DGCL, our directors and officers for monetary damages for actions taken as a director or officer, or for serving at our request as a director or officer or another position at another corporation or enterprise, as the case may be. Our amended and restated certificate of incorporation also provides that we must advance reasonable expenses to directors and officers, subject to receipt of an undertaking from the indemnified party as may be required under the DGCL. Anti-Takeover Effects of Provisions of Our Charter Documents Provisions of our amended and restated certificate of incorporation and amended and restated bylaws could have the effect of delaying, deferring or discouraging another party from acquiring control of our company. These provisions, which are summarized below, may have the effect of discouraging takeover bids. These provisions are also designed, in part, to encourage persons seeking to acquire control of the company to first negotiate with the board of directors. The benefits of increased protection of the potential ability to negotiate with an unfriendly or unsolicited acquirer outweigh the disadvantages of discouraging a proposal to acquire the company because negotiation of these proposals could result in an improvement of their terms. Undesignated Preferred Stock The authority of our board of directors to issue preferred stock could potentially be used to discourage attempts by third parties to obtain control of our company through a merger, tender offer, proxy contest or otherwise by making it more difficult EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. or more costly to obtain control of the company. The board of directors may issue preferred stock with voting rights or conversion rights that, if exercised, could adversely affect the voting power of the holders of common stock. Indemnification We are also expressly authorized by the DGCL to carry directors’ and officers’ insurance to protect the company, its directors, officers and certain employees for some liabilities. The indemnification and advancements provisions in our amended and restated certificate of incorporation and amended and restated bylaws, respectively, may discourage stockholders from bringing a lawsuit against directors for breach of their fiduciary duties. These provisions may also have the effect of reducing the likelihood of derivative litigation against directors and officers, even though such an action, if successful, might otherwise benefit our company and its stockholders. The indemnification provisions will not alter the liability of directors under the federal securities laws. In addition, your investment may be adversely affected to the extent that, in a derivative or direct suit, our company pays the litigation costs of the directors and officers and the costs of settlement and damage awards against directors and officers pursuant to these indemnification and advancements provisions. We maintain standard policies of insurance that provide coverage (i) to directors and officers against loss arising from claims made by reason of breach of duty or other wrongful act and (ii) to us with respect to indemnification and advancements payments that it may make to such directors and officers. We have entered into indemnification agreements with each of our officers and directors. These agreements require us to indemnify these individuals to the fullest extent permitted under Delaware law against liabilities that may arise by reason of their service to our company, and to advance expenses incurred as a result of any proceeding against them as to which they could be indemnified. The limitation of liability provision in our amended and restated certificate of incorporation and the indemnification agreements may facilitate our ability to continue to attract and retain qualified individuals to serve as directors and officers. Insofar as the above described indemnification provisions permit indemnification of directors, officers or persons controlling our company for liability arising under the Securities Act, in the opinion of the SEC, this indemnification is against public policy as expressed in the Securities Act and is therefore unenforceable. Amended and Restated Certificate of Incorporation and Amended and Restated Bylaws Among other things, our amended and restated certificate of incorporation and amended and restated bylaws: • • • • • • • • • permit our board of directors to issue up to 10,000,000 shares of preferred stock, with any rights, preferences and privileges as they may designate, including the right to approve an acquisition or other change of control; provide that the authorized number of directors may be changed only by resolution of our board of directors; provide that our board of directors will be classified into three classes of directors; provide that, subject to the rights of any series of preferred stock to elect directors, directors may only be removed for cause, which removal may be effected, subject to any limitation imposed by law, by the holders of at least a majority of the voting power of all of our then-outstanding shares of the capital stock entitled to vote generally at an election of directors; provide that all vacancies, including newly created directorships, may, except as otherwise required by law, be filled by the affirmative vote of a majority of directors then in office, even if less than a quorum; require that any action to be taken by our stockholders must be effected at a duly called annual or special meeting of stockholders and not be taken by written consent or electronic transmission; provide that stockholders seeking to present proposals before a meeting of stockholders or to nominate candidates for election as directors at a meeting of stockholders must provide advance notice in writing, and also specify requirements as to the form and content of a stockholder’s notice; provide that special meetings of our stockholders may be called only by the chairman of our board of directors, our chief executive officer or by our board of directors pursuant to a resolution adopted by a majority of the total number of authorized directors; and not provide for cumulative voting rights, therefore allowing the holders of a majority of the shares of common stock entitled to vote in any election of directors to elect all of the directors standing for election, if they should so choose. EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. The amendment of any of these provisions would require approval by the holders of at least 66 2/3% of the voting power of all of our then-outstanding common stock entitled to vote generally in the election of directors, voting together as a single class. The combination of these provisions will make it more difficult for our existing stockholders to replace our board of directors as well as for another party to obtain control of us by replacing our board of directors. Since our board of directors has the power to retain and discharge our officers, these provisions could also make it more difficult for existing stockholders or another party to effect a change in management. In addition, the authorization of undesignated preferred stock makes it possible for our board of directors to issue preferred stock with voting or other rights or preferences that could impede the success of any attempt to change our control. These provisions are intended to enhance the likelihood of continued stability in the composition of our board of directors and its policies and to discourage coercive takeover practices and inadequate takeover bids. These provisions are also designed to reduce our vulnerability to hostile takeovers and to discourage certain tactics that may be used in proxy fights. However, such provisions could have the effect of discouraging others from making tender offers for our shares and may have the effect of delaying changes in our control or management. As a consequence, these provisions may also inhibit fluctuations in the market price of our stock that could result from actual or rumored takeover attempts. We believe that the benefits of these provisions, including increased protection of our potential ability to negotiate with the proponent of an unfriendly or unsolicited proposal to acquire or restructure our company, outweigh the disadvantages of discouraging takeover proposals, because negotiation of takeover proposals could result in an improvement of their terms. Choice of Forum Our amended and restated certificate of incorporation and amended and restated bylaws each provide that the Court of Chancery of the State of Delaware will, to the fullest extent permitted by applicable law, be the sole and exclusive forum for (i) any derivative action or proceeding brought on behalf of the corporation, (ii) any action asserting a claim of breach of a fiduciary duty owed by any director, officer, or other employee of the corporation to the corporation or the corporation’s stockholders, (iii) any action asserting a claim arising pursuant to any provision of the Delaware General Corporation Law, or (iv) any action asserting a claim that is governed by the internal affairs doctrine. These exclusive-forum provisions will not apply to suits brought to enforce a duty or liability created by the Exchange Act or any other claim for which the U.S. federal courts have exclusive jurisdiction. Our stockholders cannot waive compliance with the federal securities laws and the rules and regulations thereunder. Our amended and restated bylaws further provide that, unless we consent in writing to the selection of an alternative forum, the federal district courts of the United States of America shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act, subject to and contingent upon a final adjudication in the State of Delaware of the enforceability of such exclusive forum provision. The Court of Chancery of the State of Delaware recently determined that a provision stating that U.S. federal district courts are the exclusive forum for resolving any complaint asserting a cause of action arising under the Securities Act is not enforceable. However, this decision may be reviewed and ultimately overturned by the Delaware Supreme Court. Any person or entity purchasing or otherwise acquiring any interest in shares of our capital stock will be deemed to have notice of and consented to the foregoing forum selection provisions. These exclusive-forum provisions may limit a stockholder’s ability to bring a claim in a judicial forum that it finds favorable for disputes with us or our directors, officers, employees or agents, which may discourage such lawsuits against us and such persons. Our amended and restated certificate of incorporation does not contain a similar provision providing that the federal district courts of the United States shall be the exclusive forum for the resolution of any complaint asserting a cause of action arising under the Securities Act or the rules and regulations thereunder because the provision is included in our amended and restated bylaws. If any court of competent jurisdiction were to find this exclusive-forum provision in our amended and restated bylaws to be inapplicable or unenforceable, including due to its absence from our amended and restated certificate of incorporation, we may incur additional costs associated with resolving such matters in other jurisdictions. For example, if the Delaware Supreme Court does not ultimately overturn the Court of Chancery’s recent determination that such a provision is not enforceable, we may incur similar additional costs. Anti-Takeover Effects of Delaware Law Our company is subject to the provisions of Section 203 of the DGCL regulating corporate takeovers. In general, Section 203 generally prohibits a publicly- held Delaware corporation from engaging in a business combination with an interested stockholder for a period of three years following the date on which the person became an interested stockholder unless: • prior to the date of the transaction, the board of directors of the corporation approved either the business combination or the transaction which resulted in the stockholder becoming an interested stockholder; EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. • • upon completion of the transaction that resulted in the stockholder becoming an interested stockholder, the interested stockholder owned at least 85% of the voting stock of the corporation outstanding at the time the transaction commenced, excluding for purposes of determining the voting stock outstanding, but not the outstanding voting stock owned by the interested stockholder, (1) shares owned by persons who are directors and also officers and (2) shares owned by employee stock plans in which employee participants do not have the right to determine confidentially whether shares held subject to the plan will be tendered in a tender or exchange offer; or at or subsequent to the date of the transaction, the business combination is approved by the board of directors of the corporation and authorized at an annual or special meeting of stockholders, and not by written consent, by the affirmative vote of at least 66 2/3% of the outstanding voting stock that is not owned by the interested stockholder. In general, Section 203 defines business combination to include the following: • • • • • any merger or consolidation involving the corporation and the interested stockholder; any sale, lease, exchange, mortgage, transfer, pledge or other disposition of 10% or more of either the assets or outstanding stock of the corporation involving the interested stockholder; subject to certain exceptions, any transaction that results in the issuance or transfer by the corporation of any stock of the corporation to the interested stockholder; any transaction involving the corporation that has the effect of increasing the proportionate share of the stock of any class or series of the corporation beneficially owned by the interested stockholder; or the receipt by the interested stockholder of the benefit of any loans, advances, guarantees, pledges or other financial benefits by or through the corporation. In general, Section 203 defines interested stockholder as an entity or person who, together with affiliates and associates, beneficially owns, or within three years prior to the determination of interested stockholder status did own, 15% or more of the outstanding voting stock of the corporation. The provisions of Delaware law and our amended and restated certificate of incorporation and amended and restated bylaws could have the effect of discouraging others from attempting hostile takeovers and, as a consequence, they may also inhibit temporary fluctuations in the market price of our common stock that often result from actual or rumored hostile takeover attempts. These provisions may also have the effect of preventing changes in management. It is possible that these provisions may make it more difficult to accomplish transactions that stockholders may otherwise deem to be in their best interests. Transfer Agent and Registrar Our common stock is listed on Nasdaq under the symbol “APEN.” The transfer agent and registrar for the common stock is Nevada Agency and Transfer Company. Its address is 50 West Liberty Street, Suite 880, Reno, Nevada, 89501, and its telephone number is (775) 322-0626. Listing Our common stock is listed on the Nasdaq Global Select Market under the symbol “APEN.” EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. Consent of Independent Registered Public Accounting Firm Exhibit 23.1 The Board of Directors Apollo Endosurgery, Inc.: We consent to the incorporation by reference in the registration statements of Apollo Endosurgery, Inc. on Form S-8 (Nos. 333-215817, 333-218773, 333- 223461 and 333-231202) and on Form S-3 (Nos. 333-233439 and 333-221893), of our report dated March 26, 2020, with respect to the consolidated balance sheets of Apollo Endosurgery, Inc. and subsidiaries as of December 31, 2019 and 2018, the related consolidated statements of operations and comprehensive loss, changes in stockholders’ equity, and cash flows for the years then ended, and the related notes, which report appears in the December 31, 2019 annual report on Form 10-K of Apollo Endosurgery, Inc. Our audit report dated March 26, 2020 contains an explanatory paragraph that states that the Company has suffered recurring losses from operations, cash flow deficits and debt covenant violations and has an accumulated deficit, which raise substantial doubt about its ability to continue as a going concern. The consolidated financial statements do not include any adjustments that might result from the outcome of this uncertainty. Austin, Texas March 26, 2020 /s/ KPMG LLP EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. CERTIFICATION OF PRINCIPAL EXECUTIVE OFFICER PURSUANT TO RULE 13a-14(a) AND 15d-14(a) OF THE SECURITIES EXCHANGE ACT, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 31.1 I, Todd Newton, certify that: 1. I have reviewed this Annual Report on Form 10-K of Apollo Endosurgery, Inc.; and 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision; to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: March 26, 2020 By: /s/ Todd Newton Todd Newton Chief Executive Officer (Principal Executive Officer) EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. CERTIFICATION OF PRINCIPAL FINANCIAL OFFICER PURSUANT TO RULE 13a-14(a) AND 15d-14(a) OF THE SECURITIES EXCHANGE ACT, AS ADOPTED PURSUANT TO SECTION 302 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 31.2 I, Stefanie Cavanaugh, certify that: 1. I have reviewed this Annual Report on Form 10-K of Apollo Endosurgery, Inc.; and 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have: a. Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; b. Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision; to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles; c. Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and d. Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and 5. The registrant's other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions): a. All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and b. Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting. Date: March 26, 2020 By: /s/Stefanie Cavanaugh Stefanie Cavanaugh Chief Financial Officer (Principal Financial Officer) EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. CERTIFICATION OF CHIEF EXECUTIVE OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 32.1 Pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350), Todd Newton, Chief Executive Officer of Apollo Endosurgery, Inc. (the “Company”), hereby certifies that: 1. The Company’s Annual Report on Form 10-K for the period ended December 31, 2019, to which this Certification is attached as Exhibit 32.1 (the “Annual Report”), fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 26, 2020 By: /s/ Todd Newton Todd Newton Chief Executive Officer (Principal Executive Officer) A signed original of this written statement required by Section 906 has been provided to Apollo Endosurgery, Inc. and will be retained by Apollo Endosurgery, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. This certification accompanies the Form 10-K to which it relates, is not deemed filed with the Securities and Exchange Commission, and is not to be incorporated by reference into any filing of Apollo Endosurgery, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any general incorporation language contained in such filing. EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. CERTIFICATION OF CHIEF FINANCIAL OFFICER PURSUANT TO 18 U.S.C. SECTION 1350 AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Exhibit 32.2 Pursuant to the requirement set forth in Rule 13a-14(b) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and Section 1350 of Chapter 63 of Title 18 of the United States Code (18 U.S.C. §1350), Stefanie Cavanaugh, Chief Financial Officer of Apollo Endosurgery, Inc. (the “Company”), hereby certifies that: 1. The Company’s Annual Report on Form 10-K for the period ended December 31, 2019, to which this Certification is attached as Exhibit 32.2 (the “Annual Report”), fully complies with the requirements of Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended; and 2. The information contained in the Annual Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Date: March 26, 2020 By: /s/Stefanie Cavanaugh Stefanie Cavanaugh Chief Financial Officer (Principal Financial Officer) A signed original of this written statement required by Section 906 has been provided to Apollo Endosurgery, Inc. and will be retained by Apollo Endosurgery, Inc. and furnished to the Securities and Exchange Commission or its staff upon request. This certification accompanies the Form 10-K to which it relates, is not deemed filed with the Securities and Exchange Commission, and is not to be incorporated by reference into any filing of Apollo Endosurgery, Inc. under the Securities Act of 1933, as amended, or the Securities Exchange Act of 1934, as amended (whether made before or after the date of the Form 10-K), irrespective of any general incorporation language contained in such filing. EDGAR Stream is a copyright of Issuer Direct Corporation, all rights reserved. 

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