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EX-32.2 - EXHIBIT 32.2 - Conformis Inccfms-063020xex322.htm
EX-32.1 - EXHIBIT 32.1 - Conformis Inccfms-063020xex321.htm
EX-31.2 - EXHIBIT 31.2 - Conformis Inccfms-063020xex312.htm
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EX-10.2 - EXHIBIT 10.2 - Conformis Incex_102xconformisformofglob.htm
EX-10.1 - EXHIBIT 10.1 - Conformis Incex_101xconformissalesagree.htm
EX-5.1 - EXHIBIT 5.1 - Conformis Incex_51xwhx2020xatm.htm
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
(Mark One)
 
x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the quarterly period ended June 30, 2020
 
OR
 
¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
 
For the transition period from                      to                     
 
Commission file number: 001-37474
 
Conformis, Inc.
(Exact name of registrant as specified in its charter)
 
Delaware
56-2463152
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification Number)
600 Technology Park Drive
Billerica, MA
01821
(Address of principal executive offices)
(Zip Code)
 
(781) 345-9001
(Registrant’s telephone number, including area code)

(Former name, former address and former fiscal year, if changed since last report)
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes   x   No  ¨
 
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).    Yes  x    No  ¨
 
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” and "emerging growth company," in Rule 12b-2 of the Exchange Act.

Large accelerated filer
o
Accelerated filer
o

 
 
 
 
Non-accelerated filer
x  
Smaller reporting company
x 
 
 
 
 
 
 
Emerging growth company
x 
 
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
x 

 Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

Securities registered pursuant to Section 12(b) of the Act:
Title of each class
Trading Symbol(s)
Name of each exchange on which registered
Common Stock
CFMS
Nasdaq
 
As of July 31, 2020, there were 77,555,538 shares of Common Stock, $0.00001 par value per share, outstanding.

 




Conformis, Inc.
 
INDEX
 
 
Page
 
 
 
 
 
 




PART I - FINANCIAL INFORMATION

Item 1.   FINANCIAL STATEMENTS
CONFORMIS, INC. AND SUBSIDIARIES
 
Consolidated Balance Sheets
(in thousands, except share and per share data)
 
June 30, 2020
 
December 31, 2019
 
(unaudited)
 
 
Assets
 
 
 
Current Assets
 

 
 

Cash and cash equivalents
$
18,168

 
$
26,394

Accounts receivable, net
8,186

 
11,066

Royalty and licensing receivable
6,197

 
165

Inventories, net
13,181

 
12,074

Prepaid expenses and other current assets
2,223

 
2,815

Total current assets
47,955

 
52,514

Property and equipment, net
13,755

 
13,356

Operating lease right-of-use assets
5,274

 
5,853

Other Assets
 

 
 

Restricted cash
462

 
462

Other long-term assets
189

 
211

Total assets
$
67,635

 
$
72,396

 
 
 
 
Liabilities and stockholders' equity
 

 
 

Current liabilities
 

 
 

Accounts payable
$
6,443

 
$
6,920

Accrued expenses
7,014

 
7,135

Operating lease liabilities
1,489

 
1,469

Advance on research and development
3,149

 
2,331

Contract liability
12,000

 

Total current liabilities
30,095

 
17,855

Other long-term liabilities

 
1,500

Contract liability

 
12,000

Long-term debt, less debt issuance costs
24,664

 
19,623

Operating lease liabilities
4,433

 
5,071

Total liabilities
59,192

 
56,049

Commitments and contingencies


 


Stockholders’ equity
 

 
 

Preferred stock, $0.00001 par value:
 

 
 

Authorized: 5,000,000 shares authorized at June 30, 2020 and December 31, 2019; no shares issued and outstanding as of June 30, 2020 and December 31, 2019

 

Common stock, $0.00001 par value:
 

 
 

Authorized: 200,000,000 shares authorized at June 30, 2020 and December 31, 2019; 76,103,605 and 70,427,400 shares issued and outstanding at June 30, 2020 and December 31, 2019, respectively
1

 
1

Additional paid-in capital
524,991

 
521,356

Accumulated deficit
(515,633
)
 
(504,145
)
Accumulated other comprehensive loss
(916
)
 
(865
)
Total stockholders’ equity
8,443

 
16,347

Total liabilities and stockholders’ equity
$
67,635

 
$
72,396

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

1


CONFORMIS, INC. AND SUBSIDIARIES
 
Consolidated Statements of Operations
(unaudited)
(in thousands, except share and per share data)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2020
 
2019
 
2020
 
2019
Revenue
 

 
 

 
 

 
 

Product
$
9,743

 
$
19,337

 
$
26,033

 
$
39,806

Royalty and licensing
9,725

 
256

 
9,910

 
431

Total revenue
19,468

 
19,593

 
35,943

 
40,237

Cost of revenue
8,450

 
9,971

 
17,711

 
20,784

Gross profit
11,018

 
9,622

 
18,232

 
19,453

 
 
 
 
 
 
 
 
Operating expenses
 

 
 

 
 

 
 

Sales and marketing
4,102

 
6,897

 
10,665

 
15,078

Research and development
2,738

 
3,328

 
5,728

 
6,240

General and administrative
6,474

 
5,289

 
12,210

 
10,618

Total operating expenses
13,314

 
15,514

 
28,603

 
31,936

Loss from operations
(2,296
)
 
(5,892
)
 
(10,371
)
 
(12,483
)
 
 
 
 
 
 
 
 
Other income and expenses
 

 
 

 
 

 
 

Interest income
23

 
91

 
58

 
198

Interest expense
(584
)
 
(1,337
)
 
(1,158
)
 
(1,790
)
Foreign currency exchange transaction income (loss)
694

 
398

 
(20
)
 
(255
)
Total other income (expenses)
133

 
(848
)
 
(1,120
)
 
(1,847
)
Loss before income taxes
(2,163
)
 
(6,740
)
 
(11,491
)
 
(14,330
)
Income tax provision
(28
)
 
23

 
(3
)
 
14

 
 
 
 
 
 
 
 
Net loss
$
(2,135
)
 
$
(6,763
)
 
$
(11,488
)
 
$
(14,344
)
 
 
 
 
 
 
 
 
Net loss per share
 
 
 
 
 
 
 
Basic and diluted
$
(0.03
)
 
$
(0.11
)
 
$
(0.17
)
 
$
(0.23
)
Weighted average common shares outstanding
 
 
 
 
 
 
 
Basic and diluted
68,187,128

 
63,333,737

 
67,885,622

 
63,092,874

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

2


CONFORMIS, INC. AND SUBSIDIARIES
 
Consolidated Statements of Comprehensive Loss
(unaudited)
(in thousands)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2020
 
2019
 
2020
 
2019
Net loss
$
(2,135
)
 
$
(6,763
)
 
$
(11,488
)
 
$
(14,344
)
Other comprehensive loss
 

 
 

 
 
 
 
Foreign currency translation adjustments
(663
)
 
(402
)
 
(51
)
 
218

Comprehensive loss
$
(2,798
)
 
$
(7,165
)
 
$
(11,539
)
 
$
(14,126
)
 
The accompanying notes are an integral part of these consolidated financial statements.


3


CONFORMIS, INC. AND SUBSIDIARIES
 
Consolidated Statements of Changes in Stockholders' Equity
(unaudited)
(in thousands, except share and per share data)

 
Three Months Ended June 30, 2020
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Loss
 
 
 
Shares
 
Par Value
 
 
 
 
Total
Balance, March 31, 2020
71,505,724

 
$
1

 
$
523,265

 
$
(513,498
)
 
$
(253
)
 
$
9,515

Issuance of common stock—restricted stock
3,657,838

 

 

 
 
 
 
 

Issuance of common stock—LPC offering
200,000

 

 
174

 
 
 
 
 
174

Issuance of common stock— ATM offering
740,043

 

 
707

 
 
 
 
 
707

Compensation expense related to issued stock options and restricted stock awards
 
 
 
 
845

 
 
 
 
 
845

Net loss
 
 
 
 
 
 
(2,135
)
 
 
 
(2,135
)
Other comprehensive income
 
 
 
 
 
 
 
 
(663
)
 
(663
)
Balance, June 30, 2020
76,103,605

 
$
1

 
$
524,991

 
$
(515,633
)
 
$
(916
)
 
$
8,443


 
Six Months Ended June 30, 2020
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Loss
 
 
 
Shares
 
Par Value
 
 
 
 
Total
Balance, December 31, 2019
70,427,400

 
$
1

 
$
521,356

 
$
(504,145
)
 
$
(865
)
 
$
16,347

Issuance of common stockrestricted stock
3,736,162

 

 
2

 
 
 
 
 
2

Issuance of common stockLPC offering
1,200,000

 

 
1,317

 
 
 
 
 
1,317

Issuance of common stock ATM offering
740,043

 

 
705

 
 
 
 
 
705

Compensation expense related to issued stock options and restricted stock awards
 
 
 
 
1,611

 
 
 
 
 
1,611

Net loss
 
 
 
 
 
 
(11,488
)
 
 
 
(11,488
)
Other comprehensive income
 
 
 
 
 
 
 
 
(51
)
 
(51
)
Balance, June 30, 2020
76,103,605

 
$
1

 
$
524,991

 
$
(515,633
)
 
$
(916
)
 
$
8,443


 
Three Months Ended June 30, 2019
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive Loss
 
 
 
Shares
 
Par Value
 
 
 
 
Total
Balance, March 31, 2019
67,880,664

 
$
1

 
$
514,484

 
$
(483,248
)
 
$
(850
)
 
$
30,387

Issuance of common stock—option exercise
34,669

 

 
121

 
 
 
 
 
121

Issuance of common stock—restricted stock
(1,335
)
 

 

 
 
 
 
 

Issuance of common stock—Innovatus
775,194

 

 
3,000

 
 
 
 
 
3,000

Compensation expense related to issued stock options and restricted stock awards
 
 
 
 
958

 
 
 
 
 
958

Net loss
 
 
 
 
 
 
(6,763
)
 
 
 
(6,763
)
Other comprehensive income
 
 
 
 
 
 
 
 
(402
)
 
(402
)
Balance, June 30, 2019
68,689,192

 
$
1

 
$
518,563

 
$
(490,011
)
 
$
(1,252
)
 
$
27,301




4


 
Six Months Ended June 30, 2019
 
Common Stock
 
Additional Paid-In Capital
 
Accumulated Deficit
 
Accumulated Other Comprehensive (Loss) Income
 
 
 
Shares
 
Par Value
 
 
 
 
Total
Balance, December 31, 2018
65,290,879

 
$
1

 
$
513,336

 
$
(475,667
)
 
$
(1,470
)
 
$
36,200

Issuance of common stock—option exercise
34,669

 

 
121

 
 
 
 
 
121

Issuance of common stock—restricted stock
2,588,450

 

 

 
 
 
 
 

Issuance of common stock—Innovatus
775,194

 

 
3,000

 
 
 
 
 
3,000

Compensation expense related to issued stock options and restricted stock awards
 
 
 
 
2,106

 
 
 
 
 
2,106

Net loss
 
 
 
 
 
 
(14,344
)
 
 
 
(14,344
)
Other comprehensive income
 
 
 
 
 
 
 
 
218

 
218

Balance, June 30, 2019
68,689,192

 
$
1

 
$
518,563

 
$
(490,011
)
 
$
(1,252
)
 
$
27,301



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



5



CONFORMIS, INC. AND SUBSIDIARIES
 
Consolidated Statements of Cash Flows
(unaudited)
(in thousands)
 
Six Months Ended June 30,
 
2020
 
2019
Cash flows from operating activities:
 

 
 

Net loss
$
(11,488
)
 
$
(14,344
)
 
 
 
 
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 

 
 

Depreciation and amortization expense
2,189

 
2,136

Stock-based compensation expense
1,611

 
2,106

Unrealized foreign exchange loss
(15
)
 
229

Non-cash lease expense
579

 
584

Provision for bad debts on trade receivables
102

 
(19
)
Loss on extinguishment of debt

 
1,085

Non-cash interest expense
352

 
51

Amortization/accretion on investments

 
(4
)
Changes in operating assets and liabilities:
 

 
 

Accounts receivable
2,778

 
2,013

Royalty and licensing receivable
(6,032
)
 
(23
)
Inventories
(1,107
)
 
(1,104
)
Prepaid expenses and other assets
592

 
(324
)
Accounts payable, accrued expenses and other liabilities
(2,717
)
 
(564
)
Advance on research and development
819

 

Net cash used in operating activities
(12,337
)
 
(8,178
)
 
 
 
 
Cash flows from investing activities:
 

 
 

Acquisition of property and equipment
(2,588
)
 
(1,298
)
Maturity of investments

 
7,250

Net cash (used in) provided by investing activities
(2,588
)
 
5,952

 
 
 
 
Cash flows from financing activities:
 

 
 

Proceeds from exercise of common stock options

 
121

Debt issuance costs
(10
)
 
(685
)
Loss on extinguishment of debt

 
(919
)
Proceeds from issuance of debt
4,720

 
20,000

Payments on long-term debt

 
(15,000
)
Net proceeds from issuance of common stock
2,024

 
3,000

Net cash provided by financing activities
6,734

 
6,517

Foreign exchange effect on cash and cash equivalents
(35
)
 
(12
)
(Decrease) increase in cash, cash equivalents and restricted cash
(8,226
)
 
4,279

Cash, cash equivalents and restricted cash beginning of period
26,856

 
16,842

Cash, cash equivalents and restricted cash end of period
$
18,630

 
$
21,121

 
 
 
 
Supplemental information:
 

 
 

  Cash paid for interest
691

 
1,425

Non cash investing and financing activities:
 
 
 
 Operating leases right-of-use assets obtained in exchange for lease obligations

 
6,988

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

6


CONFORMIS, INC. AND SUBSIDIARIES
 
Notes to Consolidated Financial Statements
(unaudited)


Note A—Organization and Basis of Presentation
 
Conformis, Inc., and its subsidiaries (collectively, the “Company”), is a medical technology company that uses its proprietary iFit Image-to-Implant technology platform to develop, manufacture and sell joint replacement implants that are individually sized and shaped, which the Company refers to as personalized, individualized, or sometimes as customized, to fit and conform to each patient’s unique anatomy. The Company offers a broad line of sterile, personalized knee and hip implants and single-use instruments delivered to hospitals. The Company’s proprietary iFit technology platform is potentially applicable to all major joints.
 
The Company was incorporated in Delaware and commenced operations in 2004. The Company introduced its iUni and iDuo in 2007, its iTotal CR in 2011, its iTotal PS in 2015, and its Conformis Hip System in 2018. The Company has its corporate offices in Billerica, Massachusetts.

These consolidated financial statements as of June 30, 2020 and for the three and six months ended June 30, 2020 and 2019, and related interim information contained within the notes to the Consolidated Financial Statements, have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.
    
Liquidity and operations
 
Since the Company’s inception in June 2004, it has financed its operations primarily through private placements of preferred stock, its initial public offering in July 2015, other equity financings, debt and convertible debt financings, equipment purchase loans, patent licensing, and product revenue beginning in 2007. The Company has not yet attained profitability and continues to incur operating losses and negative operating cash flows, which adversely impacts the Company's ability to continue as a going concern. At June 30, 2020, the Company had an accumulated deficit of $515.6 million and cash and cash equivalents of $18.2 million, and $0.5 million in restricted cash allocated to lease deposits.

In December 2019, a human infection originating in China was traced to a novel strain of coronavirus. The virus subsequently spread to other parts of the world, including the United States and Europe, and caused unprecedented disruptions in the global economy as efforts to contain the spread of the virus intensified. In March 2020, the World Health Organization declared this coronavirus outbreak (COVID-19) to be a pandemic. The future progression of the pandemic and its effects on the Company's business and operations are highly uncertain. The Company has experienced significantly decreased demand for its products and expects further unpredictable and potentially significant reductions in demand for its products as healthcare providers and individuals continue to de-prioritize and defer medical procedures that are deemed to be elective, such as joint replacement procedures, which has had and will continue to have a material adverse effect on its business, operations and financial condition.
Uncertainties related to the COVID-19 pandemic, the timing of completion of the milestones set forth in the Stryker Agreement, and the Company's ability to raise capital raise substantial doubt about the Company's ability to continue as a going concern. The Company’s consolidated financial statements have been prepared assuming that the Company will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
The Company may need to engage in additional equity or debt financings to secure additional funds. The Company may not be able to obtain additional financing on terms favorable to it, or at all. To the extent that the Company raises additional capital through the future sale of equity or debt, the ownership interests of its existing stockholders will be diluted. The terms of these future equity or debt securities may include liquidation or other preferences that adversely affect the rights of the Company's existing common stockholders or involve negative covenants that restrict the Company's ability to take specific actions, such as incurring additional debt or making capital expenditures.

7


On March 20, 2020, the Company provided notice to its employees of a furlough of approximately 80 employees, effective as of March 23, 2020, to help address decreased demand for its products. The furlough resulted in limited production capacity at the Company's manufacturing facilities, but sufficient to meet demand. While the Company has not experienced significant interruptions in its supply chain, extended or additional quarantines, travel restrictions and other measures may significantly impact the ability of employees of its third-party suppliers to get to their places of work to manufacture the key components and materials necessary for the Company's products. The Company has experienced and may experience further shortages of mask and gown consumables used in its clean room processes, which may further limit the production capacity and further delay the joint replacement procedures in which its products are used. Any delay or shortage of such components or materials or delays in delivering its products may result in its inability to satisfy consumer demand for its products in a timely manner or at all, which could harm its reputation, future sales, profitability and financial condition. On April 17, 2020, the Company entered into an approximately $4.7 million promissory note (the “PPP Note”) with East West Bank as the lender under the Paycheck Protection Program (“PPP”) offered by the U.S. Small Business Administration (the "SBA") to mitigate the negative financial and operational impacts of the pandemic. Due in large part to the PPP loan made available, on April 23, 2020, the Company accelerated a plan to return to full-time employment the vast majority of those employees who were furloughed on March 23, 2020. This plan was completed at the end of April 2020.

In January 2017, the Company filed a shelf registration statement on Form S-3, which was declared effective by the Securities and Exchange Commission ("SEC") on May 9, 2017 (the "2017 Shelf Registration Statement"). The 2017 Shelf Registration Statement allowed the Company to sell from time to time up to $200 million of common stock, preferred stock, debt securities, warrants, or units comprised of any combination of these securities, for its own account in one or more offerings. On May 10, 2017, the Company filed with the SEC a prospectus supplement, for the sale and issuance of up to $50 million of its common stock and entered into an Equity Distribution Agreement (“Distribution Agreement”) with Canaccord Genuity LLC (formerly, Canaccord Genuity Inc.) ("Canaccord") pursuant to which Canaccord agreed to sell shares of the Company's common stock from time to time, as its agent, in an “at-the-market” ("ATM") offering as defined in Rule 415 promulgated under the U.S. Securities Act of 1933, as amended (the "Securities Act"). The Company was not obligated to sell any shares under the Distribution Agreement. As of June 30, 2020, the Company had sold 2,610,112 shares under the Distribution Agreement resulting in net proceeds of $4.3 million. On August 4, 2020, the Company and Canaccord mutually agreed to terminate the Distribution Agreement, effective upon the filing of this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2020 with the SEC. As of August 4, 2020, the Company had sold 2,663,000 shares under the Distribution Agreement resulting in net proceeds of $4.4 million.
              
On March 23, 2020, the Company filed a new shelf registration statement on Form S-3 (the "New Shelf Registration Statement"). Under the New Shelf Registration Statement, the Company is permitted to sell from time to time up to $200 million of common stock, preferred stock, debt securities, warrants, or units comprised of any combination of these securities, for its own account in one or more offerings. The New Shelf Registration Statement is intended to provide the Company flexibility to conduct sales of its registered securities, subject to market conditions and the Company's future capital needs. The terms of any offering under the New Shelf Registration Statement will be established at the time of such offering and will be described in a prospectus supplement filed with the SEC prior to the completion of any such offering.

On August 5, 2020, the Company filed with the SEC a prospectus supplement, for the sale and issuance of up to $25 million of its common stock and entered into a sales agreement (the “Sales Agreement”) with Cowen and Company, LLC (“Cowen”) pursuant to which the Company may offer and sell shares of the Company’s common stock to or through Cowen, acting as agent and/or principal, from time to time, in an “at-the-market” offering as defined in Rule 415 promulgated under the Securities Act, including without limitation sales made by means of ordinary brokers’ transactions on the Nasdaq Global Select Market or otherwise at market prices prevailing at the time of sale, in block transactions, or as otherwise directed by the Company. Cowen will use commercially reasonable efforts to sell the Common Stock from time to time, based upon instructions from the Company (including any price, time or size limits or other customary parameters or conditions the Company may impose). The Company will pay Cowen a commission of up to 3.0% of the gross sales proceeds of any Common Stock sold through Cowen under the Sales Agreement, and also has provided Cowen with customary indemnification rights. The shares of Common Stock being offered pursuant to the Sales Agreement will be offered and sold pursuant to the New Shelf Registration Statement. The Company is not obligated to make any sales of Common Stock under the Sales Agreement. The offering of shares of Common Stock pursuant to the Sales Agreement will terminate upon the earlier of (i) the sale of all Common Stock subject to the Sales Agreement or (ii) termination of the Sales Agreement in accordance with its terms.

8



On December 17, 2018, the Company entered into a stock purchase agreement (the "Stock Purchase Agreement") with Lincoln Park Capital ("LPC"). Upon entering into the Stock Purchase Agreement, the Company sold 1,921,968 shares of common stock for $1.0 million to LPC, representing a premium of 110% to the previous day's closing price. As consideration for LPC’s commitment to purchase shares of common stock under the Stock Purchase Agreement, the Company issued 354,430 shares to LPC.  The Company has the right at its sole discretion to sell to LPC up to $20.0 million worth of shares over a 36-month period subject to the terms of the Stock Purchase Agreement. The Company controls the timing of any sales to LPC and LPC will be obligated to make purchases of the Company's common stock upon receipt of requests from the Company in accordance with the terms of the Stock Purchase Agreement. There are no upper limits to the price per share LPC may pay to purchase up to $20.0 million worth of common stock subject to the Stock Purchase Agreement, and the purchase price of the shares will be based on the then prevailing market prices of the Company's shares at the time of each sale to LPC as described in the Stock Purchase Agreement, provided that LPC will not be obligated to make purchases of the Company's common stock pursuant to receipt of a request from the Company on any business day on which the last closing trade price of the Company's common stock on the Nasdaq Capital Market (or alternative national exchange in accordance with the Stock Purchase Agreement) is below a floor price of $0.25 per share.  No warrants, derivatives, financial or business covenants are associated with the Stock Purchase Agreement and LPC has agreed not to cause or engage in any manner whatsoever, any direct or indirect short selling or hedging of shares of the Company's common stock.  The Stock Purchase Agreement may be terminated by the Company at any time, at the Company's sole discretion, without any cost or penalty. As of June 30, 2020, the Company has sold 3,121,968 shares under the Stock Purchase Agreement resulting in proceeds of $2.3 million. As of August 4, 2020, the Company had sold 4,521,968 shares under the Stock Purchase Agreement resulting in proceeds of $3.4 million.

On June 25, 2019, the Company entered into a Loan and Security Agreement (the "2019 Secured Loan Agreement") with Innovatus Life Sciences Lending Fund I, LP ("Innovatus"), as collateral agent and lender, East West Bank and the other lenders party thereto from time to time (collectively, the "Lenders"), pursuant to which the Lenders agreed to make term loans and revolving credit facility to the Company to repay existing indebtedness, for working capital and general business purposes, in a principal amount of up to $30 million. The Company used the proceeds from the debt financings to pay off its senior secured loan and security agreement (the "2017 Secured Loan Agreement") with Oxford Finance LLC ("Oxford"). In addition, Innovatus purchased approximately $3 million of the Company's common stock at the previous day's closing price (the "Private Placement"). During the first quarter of 2020, the Company reported that it may not be able to meet its second quarter revenue covenant and would work with Innovatus with the goal of adjusting the revenue covenants under the 2019 Secured Loan Agreement. On July 1, 2020, the Company entered into a Third Amendment to its Loan and Security Agreement, dated as of June 25, 2019 (the "Amendment"). The Amendment, among other things, waives the trailing six-month revenue covenant milestones that apply to the quarters ending June 30, September 30 and December 31, 2020 under the Loan Agreement and reduces the revenue covenant milestones that apply thereafter, delays until June 25, 2021 the Company’s option to prepay all, but not less than all, of the term loans advanced under the Loan Agreement and includes a new covenant that the Company raise additional capital. The Amendment also increases the Company’s minimum cash covenant to $5 million until December 31, 2020, provided that such cash covenant shall be further increased to $10 million, commencing on January 1, 2021, if the Company has not yet satisfied the new covenant relating to raising capital. The capital raise covenant in the Amendment specifies that on or before December 31, 2020, the Company shall receive aggregate gross cash proceeds of not less than $20.0 million from (i) the sale and issuance of its equity securities (including, without limitation, by means of ATM offerings, private placements, follow on public offerings), (ii) net payments received from any of patent infringement disputes with Zimmer on or after July 1, 2020 and on or before December 31 2020, (iii) net payments received from any of its other patent infringement disputes with any other party not specified in clause (ii), (iv) monetization of R&D tax credits or NOLs as part of any current or future 2020 government stimulus packages, or (v) governmental grants that are not (in whole or in part) in the form of indebtedness, or any combination of two or more of the foregoing. If the capital raise event has not occurred by December 31, 2020 and if the Company is in compliance with its revenue covenant milestones as of January 1, 2021, the period to comply with the capital raise covenant will automatically extend to June 30, 2021. During the capital raise event extension period (i) commencing on January 1, 2021 ending on (and including) March 31, 2021, the Company shall not have any indebtedness outstanding under the revolving line in excess of $2.5 million and (ii) commencing on April 1, 2021 and ending on (and including) June 30, 2021, the Company shall not have any indebtedness outstanding under the revolving line in excess of $5.0 million. For further information regarding the 2017 Secured Loan Agreement, the 2019 Secured Loan Agreement and the Amendment, see “Note I-Debt and Notes Payable” in the financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q.

9



On September 30, 2019, the Company entered into an Asset Purchase Agreement (the "Asset Purchase Agreement") with Howmedica Osteonics Corp., a subsidiary of Stryker Corporation also known as Stryker Orthopaedics ("Stryker"). In connection with entering into the Asset Purchase Agreement, the Company and Stryker also entered into a Development Agreement (the "Development Agreement"), a License Agreement (the "License Agreement"), a Distribution Agreement (the "Distribution Agreement" and, together with the Asset Purchase Agreement, the Development Agreement and the License Agreement (the "Stryker Agreements") and other ancillary agreements contemplated by the Stryker Agreements. Under the terms of the Stryker Agreements, the Company agreed to sell and license to Stryker certain assets relating to the Company's patient-specific instrumentation technology, and to develop, manufacture, and supply patient-specific instrumentation for use in connection with Stryker's "off-the-shelf" non-personalized knee implant offerings. The Company received $14 million upfront and is eligible to receive up to an additional $16 million in milestone payments pursuant to the License Agreement and the Development Agreement. As of June 30, 2020, the Company completed the first of three milestones set forth in the License Agreement and the Development Agreement and received $2.0 million for achievement of this milestone. Under the long-term Distribution Agreement, the Company will supply patient specific instrumentation to Stryker. The Stryker Agreements contain termination provisions pursuant to which, under certain circumstances, Stryker may be able to terminate the Development Agreement and oblige the Company to repay a portion of the initial payment. In other circumstances, Stryker could terminate and pay an additional fee for the right to use the Company's intellectual property to sell patient-specific instrumentation with their off-the-shelf knee offering, subject to paying the Company a sales-based royalty fee.
On May 22, 2020, the Company entered into a Settlement and License Agreement (the “Settlement and License Agreement”) with Zimmer Biomet, Zimmer US, Inc. and Biomet Manufacturing, LLC (collectively, “Zimmer Biomet”) as discussed in Note H-Commitments and Contingencies, Legal proceedings, which provided the Company with $9.6 million of royalty and licensing revenue for the quarter ended June 30, 2020. In consideration of the licenses, releases, covenants and other immunities granted by the Company to Zimmer Biomet, Zimmer Biomet was required to pay the Company $3.5 million promptly after execution of the Settlement and License Agreement, which it has, and additional payments on specified dates through January 15, 2021, for a total amount payable of $9.6 million.
The Company funds its operations, capital expenditure requirements and debt service with existing cash and cash equivalents as of June 30, 2020, and plans to address matters that raise substantial doubt about the Company's ability to continue as a going concern through anticipated revenue from operations, the successful completion of the milestones set forth in the Development Agreement and License Agreement, revenue that may be generated in connection with licensing its intellectual property, available sales of shares under the Sales Agreement and the Stock Purchase Agreement, and available borrowings under the revolving credit facility. In order for the Company to meet its operating plan, gross margin improvements and leveraging operating expenses will be necessary to reduce cash used in operations, and the Company will need to successfully complete milestones set forth in the Development Agreement and the License Agreement which cannot be assured. When the Company needs additional equity or debt financing proceeds to fund its operations, the Company may not be able to obtain additional financing on terms favorable to the Company, or at all.

Basis of presentation and use of estimates
 
The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States 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 revenue and expenses during the reporting periods. The most significant estimates used in these consolidated financial statements include revenue recognition, accounts receivable valuation, inventory reserves, purchase accounting, impairment assessments, equity instruments, stock compensation, income tax reserves and related allowances, and the lives of property and equipment, and valuation of right-of-use lease assets and lease liabilities. Actual results may differ from those estimates. The interim financial statements should be read in conjunction with the audited financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2019.


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Unaudited Interim Financial Information

The accompanying Interim Consolidated Financial Statements as of June 30, 2020 and for the three and six months ended June 30, 2020 and 2019, and related interim information contained within the notes to the Consolidated Financial Statements are unaudited. These unaudited interim consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States ("U.S. GAAP"). In management’s opinion, the unaudited interim consolidated financial statements have been prepared on the same basis as the audited financial statements and include all adjustments (including normal recurring adjustments) necessary for the fair presentation of the Company’s financial position as of June 30, 2020, results of operations for and stockholders' equity for the three and six months ended June 30, 2020 and 2019, and comprehensive loss, and cash flows for the six months ended June 30, 2020 and 2019. The results for the three and six months ended June 30, 2020 are not necessarily indicative of the results expected for the full year or any interim period.


Note B—Summary of Significant Accounting Policies
 
The Company's financial results are affected by the selection and application of accounting policies and methods. There were no material changes in the six months ended June 30, 2020 to the application of significant accounting policies and estimates as described in its audited consolidated financial statements for the year ended December 31, 2019.

Concentrations of credit risk and other risks and uncertainties
     Financial instruments that subject the Company to credit risk primarily consist of cash, cash equivalents, and accounts receivable. The Company maintains the majority of its cash with accredited financial institutions.
 
The Company and its contract manufacturers rely on sole source suppliers and service providers for certain components. There can be no assurance that a shortage or stoppage of shipments of the materials or components that the Company purchases will not result in a delay in production or adversely affect the Company’s business. On an ongoing basis, the Company validates alternate suppliers relative to certain key components as needed.
 
For the three and six months ended June 30, 2020, Zimmer Biomet represented 49% and 27% of total revenue, respectively. For the three and six months ended June 30, 2019, no customer represented greater than 10% of total revenue. As of June 30, 2020, payments due from Zimmer Biomet represented 42% of our total net receivable balance. As of December 31, 2019, there were no customers that represented greater than 10% of the total net receivable balance.
 
Principles of consolidation
     The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries ImaTx, Inc. ("ImaTx"); ConforMIS Europe GmbH; ConforMIS UK Limited; ConforMIS Hong Kong Limited; and Conformis Cares LLC. All intercompany balances and transactions have been eliminated in consolidation.
 
Cash, cash equivalents and restricted cash
     The Company considers all highly liquid investment instruments with original maturities of 90 days or less when purchased, to be cash equivalents. The Company’s cash equivalents consist of demand deposits, money market accounts, money market funds, and repurchase agreements on deposit with certain financial institutions, in addition to cash deposits in excess of federally insured limits. Demand deposits and money market accounts are carried at cost which approximates their fair value. Money market funds are carried at fair value based upon level 1 inputs. Repurchase agreements are valued using level 2 inputs. The associated risk of concentration is mitigated by banking with credit worthy financial institutions. The Company had $0.6 million as of June 30, 2020 and $0.8 million as of December 31, 2019 held in foreign bank accounts that are not federally insured. In addition, the Company has recorded restricted cash of $0.5 million as of June 30, 2020 and December 31, 2019. Restricted cash consisted of security provided for lease obligations.

The following table provides a reconciliation of cash, cash equivalents, and restricted cash reported within the consolidated balance sheets that sum to the total of the same such amounts shown in the consolidated statements of cash flows.

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June 30,
2020
 
December 31,
2019
Cash and cash equivalents
$
18,168

 
$
26,394

Restricted cash
462

 
462

Total cash, cash equivalents, and restricted cash shown in the statement of cash flows
$
18,630

 
$
26,856


Fair value of financial instruments
Certain of the Company’s financial instruments, including cash and cash equivalents (excluding money market funds), accounts receivable, accounts payable, accrued expenses and other liabilities are carried at cost, which approximates their fair value because of the short-term maturity. Based on borrowing rates currently available to the Company for loans with similar terms, the carrying value of the Company’s long-term debt approximates its fair value.
 
Accounts receivable and allowance for doubtful accounts
     Accounts receivable consist of billed and unbilled amounts due from medical facilities or independent distributors (the "Customer"). Upon completion of a procedure, revenue is recognized and an unbilled receivable is recorded. Under ASC No. 2014-09, Revenue from Contracts with Customers ("Topic 606" or "ASC 606"), an enforceable contract is met either at or prior to the procedure being performed. Upon receipt of a purchase order from the Customer, a billed receivable is recorded and the unbilled receivable is reversed. As a result, the unbilled receivable balance fluctuates based on the timing of the Company's receipt of purchase orders from the medical facilities. In estimating whether accounts receivable can be collected, the Company performs evaluations of customers and continuously monitors collections and payments and estimates an allowance for doubtful accounts based on the aging of the underlying invoices, collections experience to date and any specific collection issues that have been identified. The allowance for doubtful accounts is recorded in the period in which revenue is recorded or when collection risk is identified.

Inventories
     Inventories consist of raw materials, work-in-process components and finished goods. Inventories are stated at the lower of cost, determined using the first-in first-out method, or net realizable value. The Company regularly reviews its inventory quantities on hand and related cost and records a provision for any excess or obsolete inventory based on its estimated forecast of product demand and existing product configurations. The Company also reviews its inventory value to determine if it reflects the lower of cost or market, based on net realizable value. Appropriate consideration is given to inventory items sold at negative gross margin, purchase commitments and other factors in evaluating net realizable value. During the three and six months ended June 30, 2020, the Company recognized provisions of $0.7 million and $1.7 million, respectively, to adjust its inventory value to the lower of cost or net realizable value for estimated unused product related to known and potential cancelled cases, which is included in cost of revenue. During the three and six months ended June 30, 2019, the Company recognized provisions of $0.8 million and $1.3 million, respectively, to adjust its inventory value to the lower of cost or net realizable value for estimated unused product related to known and potential cancelled cases, which is included in cost of revenue.

Property and equipment
     Property and equipment is stated at cost less accumulated depreciation and is depreciated using the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized over their useful life or the life of the lease, whichever is shorter. Assets capitalized under capital leases are amortized in accordance with the respective class of assets and the amortization is included with depreciation expense. Maintenance and repair costs are expensed as incurred.


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Long-Lived Assets
     The Company tests impairment of long-lived assets when events or changes in circumstances indicate that the assets might be impaired. The amount of impairment, if any, is measured based on fair value, which is determined using estimated undiscounted cash flows to be generated from such assets or group of assets. During the three months ended June 30, 2020, there were changes in circumstances that led the Company to believe that its long-lived assets may be impaired and as such, a Step 2 analysis was performed. The Company evaluated whether the estimated undiscounted cash flows, including estimated residual value, generated from the asset group were sufficient to support the carrying value of the assets. If the cash flow estimates or the significant operating assumptions upon which they are based change in the future, the Company may be required to record impairment charges. During the three and six months ended June 30, 2020 and 2019, no such impairment charges were recognized.

Leases

The Company adopted ASU No. 2016-02-Leases ("Topic 842" or "ASC 842"), as of January 1, 2019, in accordance with ASU No. 2018-11-Leases (Topic 842) ("ASU 2018-11"), issued by the FASB in July 2018. ASU 2018-11 allows an entity to elect not to recast its comparative periods in the period of adoption when transitioning to ASC 842 (the “Comparatives Under 840 Option”). Effectively, an entity would be permitted to change its date of initial application to the beginning of the period of adoption of ASC 842. In doing so, the entity would apply ASC 840 in the comparative periods and provide the disclosures required by ASC 840 for all periods that continue to be presented in accordance with ASC 840. Further, the entity would recognize the effects of applying ASC 842 as a cumulative-effect adjustment to retained earnings as of the effective date. Under the Comparatives Under 840 Option, this date would represent the date of initial application. The Company is not required to restate comparative periods for the effects of applying ASC 842, provide the disclosures required by ASC 842 for the comparative periods, nor change how the transition requirements apply, only when the transition requirements apply. The Company elected to report results for periods after January 1, 2019 under ASC 842 and prior period amounts are reported in accordance with ASC 840.

The Company has elected not to separate non-lease components from all classes of leases. Non-lease components have been accounted for as part of the single lease component to which they are related.

Leases with an initial term of 12 months or less are not recorded on the balance sheet; the Company recognizes lease expense for these leases on a straight-line basis over the lease term.

The Company has elected the hindsight practical expedient to determine the lease term for existing leases. This practical expedient enables an entity to use hindsight in determining the lease term when considering options to extend and terminate leases as well as purchase the underlying assets.

Adoption of the new standard resulted in the recording of additional right-of-use assets and lease liabilities of $7.0 million and $7.7 million, respectively, as of January 1, 2019. The difference between the additional lease assets and lease liabilities is related to deferred rent, which was previously recorded as deferred rent within Accrued expenses and Other long-term liabilities under ASC 840. The operating lease right-of-use assets are subsequently assessed for impairment in accordance with the Company's accounting policy for long-lived assets. The adoption of the standard did not impact the Company’s consolidated net earnings and had no impact on cash flows.

 Revenue Recognition

Product Revenue Recognition


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Revenue is recognized when, or as, obligations under the terms of a contract are satisfied, which occurs when control of the promised products or services is transferred to customers. Revenue is measured as the amount of consideration the Company expects to receive in exchange for transferring products or services to a customer (“transaction price”). When determining the transaction price of a contract, an adjustment is made if payment from a customer occurs either significantly before or significantly after performance, resulting in a significant financing component. Applying the practical expedient in paragraph 606-10-32-18, the Company does not assess whether a significant financing component exists if the period between when the Company performs its obligations under the contract and when the customer pays is one year or less. None of the Company’s contracts contained a significant financing component as of June 30, 2020. Payment is typically due between 30 and 60 days from invoice.

To the extent that the transaction price includes variable consideration, such as prompt-pay discounts or rebates, the Company estimates the amount of variable consideration that should be included in the transaction price utilizing the expected value to which the Company expects to be entitled. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. Actual amounts of consideration ultimately received may differ from the Company's estimates. Estimates of variable consideration and determination of whether to include estimated amounts in the transaction price are based largely on an assessment of the Company’s anticipated performance and all information (historical, current and forecasted) that is reasonably available.
    
If the contract contains a single performance obligation, the entire transaction price is allocated to the single performance obligation. Contracts that contain multiple performance obligations require an allocation of the transaction price based on the estimated relative standalone selling prices of the promised products or services underlying each performance obligation. The Company determines standalone selling prices based on observable prices or a cost-plus margin approach when one is not available. Revenue is recognized at the time the related performance obligation is satisfied by transferring control of a promised good or service to a customer. The Company's performance obligations are satisfied at the same time, typically upon surgery, therefore, product revenue is recognized at a point in time upon completion of the surgery. Since the Company does not have contracts that extend beyond a duration of one year, there is no transaction price related to performance obligations that have not been satisfied.

Certain customer contracts include terms that allow the Company to bill for orders that are cancelled after the product is manufactured and could result in revenue recognition over time. However, the impact of adopting over time revenue recognition was deemed immaterial.

Unconditional rights to consideration are reported as receivables. Incidental items that are immaterial in the context of the contract are recognized as expense.

Royalty and Licensing Revenue Recognition

The Company receives ongoing sales-based royalties under its agreement with MicroPort Orthopedics Inc., a wholly owned subsidiary of Microport Scientific Corporation. Royalty revenue is recorded at the expected value of the royalty revenue.

On September 30, 2019 the Company entered into the Stryker Agreements. The Company determined that the Asset Purchase Agreement and the License Agreement are within the scope of ASC 606. Under the Asset Purchase Agreement and License Agreement, the Company is required to provide certain assets and the right to use the license for a specific purpose. The assets and the right to use the license are highly interdependent and is considered one performance obligation. The Company bifurcated the total transaction price of $30.0 million into two components; $5.0 million related to cost reimbursement for other services (development) and $25.0 million allocated to royalty revenue determined using the residual approach by deducting the cost reimbursement component from the total transaction price. The arrangement does not contain a significant financing component.

The Company records a contract liability when there is an obligation to transfer goods or services to a customer for which the Company has received consideration from the customer. The Company has concluded that Stryker meets the definition of a customer for a portion of the obligations under the Stryker Agreements. At June 30, 2020, the Company recorded $12.0 million as a short-term contract liability related to consideration received from the customer under the Asset Purchase Agreement and Development Agreement. The Company concluded the license rights under the License Agreement are functional when FDA 510(k) clearance is received as

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required under Milestone 3 in the License Agreement, or upon termination by Stryker and Stryker's election to purchase the license rights.

On May 22, 2020 the Company entered into a Settlement and License Agreement with Zimmer Biomet, pursuant to which both parties have agreed to terms for resolving all of their existing patent disputes. In consideration of the licenses, releases, covenants and other immunities granted by the Company to Zimmer Biomet, Zimmer Biomet was required to pay the Company $3.5 million promptly after execution of the Settlement and License Agreement, which it has, and additional payments on specified dates through January 15, 2021, for a total amount payable of $9.6 million. The agreement provides for the grant of the licenses, covenants-not-to-sue, releases, and other significant deliverables upon execution of the contract. These individual rights are not accounted for as separate performance obligations as (i) the nature of the promise, within the context of the agreement, is to transfer combined items to which the promised rights are inputs and (ii) the Company's promise to transfer each individual right described above to Zimmer Biomet is not separately identifiable from other promises in the agreement. As a result, the Company accounts for the promises in the agreement as a single performance obligation. Zimmer Biomet legally obtained control of the license and other rights upon execution of the contract. As such, the earnings process is complete and revenue is recognized upon the execution of the contract, when collectability is probable and all other revenue recognition criteria have been met within the scope of ASC 606. In connection with the settlement agreement, the Company recognized revenue of $9.6 million during the three months ended June 30, 2020. See “Note H-Commitments and Contingencies, Legal proceedings” for further discussion of the Zimmer Biomet settlement.

Disaggregation of Revenue
See "Note K—Segment and Geographic Data" for disaggregated product revenue by geography.

Variable Consideration
Revenues from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for which reserves are established and which result from rebates that are offered within contracts between the Company and some of its customers. The amount of variable consideration which is included in the transaction price may be constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period.
 
The following table summarizes activity for rebate allowance reserve (in thousands):
 
 
June 30, 2020
 
December 31, 2019
Beginning Balance
 
$
127

 
$
96

Provision related to current period sales
 
80

 
145

Adjustment related to prior period sales
 
(1
)
 
20

Payments or credits issued to customer
 
(52
)
 
(134
)
Ending Balance
 
$
154

 
$
127


Costs to Obtain and Fulfill a Contract
The Company currently expenses commissions paid for obtaining product sales. Sales commissions are paid following the manufacture and implementation of the implant. Due to the period being less than one year, the Company will apply the practical expedient, whereby the Company recognizes the incremental costs of obtaining contracts as an expense when incurred if the amortization period of the assets that the Company otherwise would have recognized is one year or less. These costs are included in sales and marketing expense. Further, the Company incurs costs to buy, build, replenish, restock, sterilize and replace the reusable instrumentation trays associated with the sale of its products and services. The reusable instrument trays are not contract specific and are used for multiple contracts and customers, therefore does not meet the criteria to capitalize under ASC 606.

Shipping and handling costs
     Shipping and handling activities prior to the transfer of control to the customer (e.g. when control transfers after delivery) are considered fulfillment activities, and not performance obligations. Amounts invoiced to customers for shipping and handling are classified as revenue. Shipping and handling costs incurred are included in general

15


and administrative expense. Shipping and handling expense was $0.3 million and $0.4 million for the three months ended June 30, 2020 and 2019, respectively, and $0.7 million and $1.0 million for the six months ended June 30, 2020 and 2019, respectively.

Taxes collected from customers and remitted to government authorities
The Company’s policy is to present taxes collected from customers and remitted to government authorities on a net basis and not to include tax amounts in revenue.

Research and development expense
The Company’s research and development costs consist of engineering, product development, quality assurance, clinical and regulatory expense. These costs primarily relate to employee compensation, including salary, benefits and stock-based compensation. The Company also incurs costs related to consulting fees, revenue share, materials and supplies, and marketing studies, including data management and associated travel expense. Research and development costs are expensed as incurred.

Advertising expense
     Advertising costs are expensed as incurred, which are included in sales and marketing. Advertising expense was $0.1 million for the three months ended June 30, 2020 and 2019, and $0.3 million and $0.2 million for the six months ended June 30, 2020 and 2019, respectively.

Segment reporting
     Operating segments are defined as components of an enterprise about which separate financial information is available and is evaluated on a regular basis by the chief operating decision-maker, or decision-making group, in deciding how to allocate resources to an individual segment and in assessing performance of the segment. The Company’s chief operating decision-maker is its chief executive officer. The Company’s chief executive officer reviews financial information presented on an aggregate basis for purposes of allocating resources and evaluating financial performance. The Company has one business segment and there are no segment managers who are held accountable for operations, operating results and plans for products or components below the aggregate Company level. Accordingly, in light of the Company’s current product offerings, management has determined that the primary form of internal reporting is aligned with the offering of the Conformis personalized joint replacement products and that the Company operates as one segment. See “Note K—Segment and Geographic Data.”
      
Foreign currency translation and transactions
     The assets and liabilities of the Company’s foreign operations are translated into U.S. dollars at current exchange rates at the balance sheet date, and income and expense items are translated at average rates of exchange prevailing during the quarter. Net translation gains and losses are recorded in Accumulated other comprehensive (loss) income. Gains and losses from foreign currency transactions denominated in foreign currencies, including intercompany balances not of a long-term investment nature, are included in the Consolidated Statements of Operations.
 
Income taxes
     Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the consolidated financial statement carrying amounts of existing assets and liabilities and their respective tax bases, operating losses and tax credit carry forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized as income in the period that includes the enactment date.

In evaluating the need for a valuation allowance, the Company considers all reasonably available positive and negative evidence, including recent earnings, expectations of future taxable income and the character of that income. In estimating future taxable income, the Company relies upon assumptions and estimates of future activity including the reversal of temporary differences. Presently, the Company believes that a full valuation allowance is required to reduce deferred tax assets to the amount expected to be realized.
 

16


The tax benefit from an uncertain tax position is only recognized if it is more likely than not that the tax position will be sustained on examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from these positions are measured based on the largest benefit that has a greater than fifty percent likelihood of being realized upon ultimate resolution. The Company reviews its tax positions on an annual basis and more frequently as facts surrounding tax positions change. Based on these future events, the Company may recognize uncertain tax positions or reverse current uncertain tax positions, the impact of which would affect the consolidated financial statements.

The Company has operations in Germany. The operating results of German operations will be permanently reinvested in that jurisdiction. As a result, the Company has only provided for income taxes at local rates when required. In April 2020, new interpretations of a German law related to intellectual property and withholding tax were released. The Company is currently evaluating whether the interpretations will have an impact on its consolidated financial statements.

The Company is subject to U.S. federal, state, and foreign income taxes. The Company recorded a provision for income taxes of $(28,000) and $23,000 for the three months ended June 30, 2020 and 2019, respectively, and $(3,000) and $14,000 for the six months ended June 30, 2020 and 2019, respectively. The Company recognizes interest and penalties related to income taxes as a component of income tax expense. As of June 30, 2020 and 2019, a cumulative balance of $42,000 and $47,000 of interest and penalties had been accrued, respectively.

On March 27, 2020, the U.S. government enacted the Coronavirus Aid, Relief, and Economic Security Act (the "CARES Act") which included modifications to the limitation on business interest expense, net operating loss provisions, and other various U.S. tax law updates. The Company does not expect that these aspects of the CARES Act will have a material impact on its consolidated financial statements.

Stock-based compensation
     The Company accounts for stock-based compensation in accordance with ASC 718, Stock Based Compensation.  ASC 718 requires all stock-based payments to employees and consultants, including grants of stock options, to be recognized in the consolidated statements of operations based on their fair values. The Company uses the Black-Scholes option pricing model to determine the weighted-average fair value of options granted and recognizes the compensation expense of stock-based awards on a straight-line basis over the vesting period of the award.
     
The determination of the fair value of stock-based payment awards utilizing the Black-Scholes option pricing model is affected by the stock price, exercise price, and a number of assumptions, including expected volatility of the stock, expected life of the option, risk-free interest rate and expected dividends on the stock. The Company evaluates the assumptions used to value the awards at each grant date and if factors change and different assumptions are utilized, stock-based compensation expense may differ significantly from what has been recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense.

Net loss per share
     The Company calculates net income (loss) per share in accordance with ASC 260, "Earnings per Share." Basic earnings per share (“EPS”) is calculated by dividing the net income or loss for the period by the weighted average number of common shares outstanding for the period, without consideration for common stock equivalents. Diluted EPS is computed by dividing the net income or loss for the period by the weighted average number of common shares outstanding for the period and the weighted average number of dilutive common stock equivalents outstanding for the period determined using the treasury stock method.
     

17


The following table sets forth the computation of basic and diluted earnings per share attributable to stockholders (in thousands, except share and per share data):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands, except share and per share data)
 
2020
 
2019
 
2020
 
2019
Numerator:
 
 

 
 

 
 

 
 

Basic and diluted loss per share
 
 

 
 

 
 

 
 

Net loss
 
$
(2,135
)
 
$
(6,763
)
 
$
(11,488
)
 
$
(14,344
)
Denominator:
 
 

 
 

 
 

 
 

Basic and diluted weighted average shares
 
68,187,128

 
63,333,737

 
67,885,622

 
63,092,874

Loss per share attributable to Conformis, Inc. stockholders:
 
 
 
 
 
 
 
 
Basic and diluted
 
$
(0.03
)
 
$
(0.11
)
 
$
(0.17
)
 
$
(0.23
)
 
The following table sets forth potential shares of common stock equivalents that are not included in the calculation of diluted net loss per share because to do so would be anti-dilutive as of the end of each period presented:
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Stock options and restricted stock awards
 
1,023,009

 
3,641,319

 
1,090,897

 
3,411,545





Note C—Accounts Receivable
 
Accounts receivable consisted of the following (in thousands):
 
June 30,
2020
 
December 31,
2019
Total receivables
$
8,542

 
$
11,401

Allowance for doubtful accounts and returns
(356
)
 
(335
)
Accounts receivable, net
$
8,186

 
$
11,066

 
Accounts receivable included unbilled receivable of $1.4 million and $2.1 million at June 30, 2020 and December 31, 2019, respectively. Write-offs related to accounts receivable were approximately $76,000 and $32,000 for the three months ended June 30, 2020 and 2019, respectively, and $71,000 and $32,000 for the six months ended June 30, 2020 and 2019, respectively.

Summary of allowance for doubtful accounts and returns activity was as follows (in thousands):
 
June 30,
2020
 
December 31,
2019
Beginning balance
$
(335
)
 
$
(390
)
Provision for bad debts on trade receivables
(102
)
 
(106
)
Other allowances
10

 
(26
)
Accounts receivable write offs
71

 
187

Ending balance
$
(356
)
 
$
(335
)


18


Note D—Inventories
 
Inventories consisted of the following (in thousands):
 
June 30,
2020
 
December 31,
2019
Raw Material
$
6,019

 
$
6,171

Work in process
886

 
1,717

Finished goods
6,276

 
4,186

Total Inventories
$
13,181

 
$
12,074


Note E—Property and Equipment
 
Property and equipment consisted of the following (in thousands):
 
Estimated
Useful
Life
(Years)
 
June 30, 2020
 
December 31, 2019
Equipment
5-7
 
$
19,334

 
$
19,011

Furniture and fixtures
5-7
 
864

 
864

Computer and software
3
 
9,654

 
9,561

Leasehold improvements
3-7
 
2,082

 
2,008

Reusable instruments
5
 
5,500

 
3,402

Total property and equipment
 
 
37,434

 
34,846

Accumulated depreciation
 
 
(23,679
)
 
(21,490
)
Property and equipment, net
 
 
$
13,755

 
$
13,356


Depreciation expense related to property and equipment was $1.1 million and $1.0 million for the three months ended June 30, 2020 and 2019, respectively, and $2.2 million and $2.1 million for the six months ended June 30, 2020 and 2019, respectively.

Note F—Accrued Expenses
 
Accrued expenses consisted of the following (in thousands):
 
June 30,
2020
 
December 31,
2019
Accrued employee compensation
$
3,120

 
$
3,198

Accrued legal expense
1,670

 
310

Accrued consulting expense
21

 
21

Accrued vendor charges
470

 
1,037

Accrued revenue share expense
409

 
1,050

Accrued clinical trial expense
254

 
394

Accrued other
1,070

 
1,125

 
$
7,014

 
$
7,135


19


Note G—Leases

The Company maintains its corporate headquarters in a leased building located in Billerica, Massachusetts. The Company maintains its manufacturing facilities in leased buildings located in Wilmington, Massachusetts and Wallingford, Connecticut.

The Company's leases have remaining lease terms of approximately one to seven years, some of which include one or more options to extend the leases for up to five years per renewal. The exercise of lease renewal options is at the sole discretion of the Company. The amounts disclosed in the Consolidated Balance Sheet pertaining to right-of-use assets and lease liabilities are measured based on management’s current expectations of exercising its available renewal options.

The Company’s existing leases are not subject to any restrictions or covenants which preclude its ability to pay dividends, obtain financing, or enter into additional leases.

As of June 30, 2020, the Company has not entered into any leases which have not yet commenced which would entitle the Company to significant rights or create additional obligations.

The Company uses either its incremental borrowing rate or the implicit rate in the lease agreement as the basis to calculate the present value of future lease payments at lease commencement. The incremental borrowing rate represents the rate the Company would have to pay to borrow funds on a collateralized basis over a similar term and in a similar economic environment.

The components of lease expense and related cash flows were as follows (in thousands):

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Rent expense
 
$
382

 
$
383

 
$
763

 
$
765

Variable lease cost (1)
 
61

 
100

 
151

 
203

 
 
$
443

 
$
483

 
$
914

 
$
968

(1) Variable operating lease expenses consist primarily of common area maintenance and real estate taxes for the three and six months ended June 30, 2020 and 2019, respectively.
 
As of June 30, 2020, the remaining weighted-average lease term of the operating leases was 4.6 years and the weighted-average discount rate was 6.0%

The future minimum rental payments under these agreements as of June 30, 2020 were as follows (in thousands):
Year
Minimum Lease Payments
2020 remainder of year
812

2021
1,633

2022
1,399

2023
1,053

After 2023
1,885

Total lease payments
$
6,782

Present value adjustment
(862
)
Present value of lease liabilities
$
5,920

 

20



Note H—Commitments and Contingencies

License and revenue share agreements

Revenue share agreements
 
The Company is party to revenue share agreements with certain past and present members of its scientific advisory board under which these advisors agreed to participate on a scientific advisory board and to assist with the development of the Company’s personalized implant products and related intellectual property. These agreements provide that the Company will pay the advisor a specified percentage of the Company’s net revenue, ranging from 0.1% to 1.33%, with respect to the Company’s products on which the advisor made a technical contribution or, in some cases, products covered by one or more claims of one or more Company patents on which the advisor is a named inventor. The specific percentage is determined by reference to product classifications set forth in the agreement and is often tiered based on the level of net revenue collected by the Company on such product sales. The Company’s payment obligations under these agreements typically expire a fixed number of years after expiration or termination of the agreement or a fixed number of years after the first sale of a product, but in some cases expire on a product-by-product basis or expiration of the last to expire of the Company’s patents where the advisor is a named inventor that claims the applicable product.
      
The Company incurred aggregate revenue share expense including all amounts payable under the Company’s scientific advisory board revenue share agreements of $0.2 million during the three months ended June 30, 2020, representing 2.4% of product revenue and $0.6 million during the six months ended June 30, 2020, representing 2.6% of product revenue, $0.7 million during the three months ended June 30, 2019, representing 3.5% of product revenue and $0.6 million during the six months ended June 30, 2019, representing 1.5% of product revenue. Revenue share expense is included in research and development.
 
Other obligations
 
In the ordinary course of business, the Company is a party to certain non-cancellable contractual obligations typically related to product royalty and research and development.  The Company accrues a liability for such matters when it is probable that future expenditures will be made and such expenditures can be reasonably estimated. There have been no contingent liabilities requiring accrual at June 30, 2020 or December 31, 2019.
 
Legal proceedings

On August 15, 2019, the Company filed a lawsuit against Zimmer Biomet Holdings, Inc. and Zimmer, Inc., (together, “Zimmer Biomet”) in the United States District Court for the District of Delaware seeking damages for Zimmer Biomet's infringement of certain of the Company’s patents related to patient-specific instrument and implant systems. The complaint alleges that Zimmer Biomet’s multiple lines of patient-specific instruments, as well as the implant components used in conjunction with them, infringe four of the Company’s patents. The accused product lines include Zimmer Biomet's patient-specific instrument and implant systems for knee, shoulder, and hip replacement procedures.

On November 5, 2019, Zimmer Biomet filed a lawsuit against the Company in the United States District Court for the District of Delaware, alleging that the Company infringes five patents owned by Zimmer Biomet. Zimmer Biomet alleges that the Company’s iTotal CR and iTotal PS products infringe all five asserted patents, that the Company’s iDuo product infringes three of the asserted patents, and that the Company’s iUni product infringes two of the asserted patents. On January 13, 2020, Zimmer Biomet filed a motion to dismiss the Company’s complaint, and the Company filed its answer to Zimmer Biomet’s complaint, denying that the Company’s products infringe Zimmer Biomet’s asserted patents. The Company’s answer also alleges that Zimmer Biomet’s asserted patents are invalid.

On May 22, 2020, the Company entered into a Settlement and License Agreement (the “Settlement and License Agreement”) with Zimmer Biomet, Zimmer US, Inc. and Biomet Manufacturing, LLC (collectively, “Zimmer Biomet”), pursuant to which the parties have agreed to terms for resolving their existing patent disputes. Under the Settlement and License Agreement, the Company and Zimmer Biomet agreed to dismiss both outstanding patent infringement lawsuits between the parties. Pursuant to the Settlement and License Agreement, the Company granted to Zimmer Biomet a royalty-free, non-exclusive, worldwide license to certain of the Company’s patents for

21


Zimmer Biomet’s patient-specific instrumentation used with off-the-shelf knee, hip, and shoulder implants, and Zimmer granted to Conformis a fully paid-up, royalty-free, non-exclusive, worldwide license to certain Zimmer Biomet patents for the Company’s implants and patient-specific instruments for the knee. Zimmer Biomet was required to pay the Company $3.5 million promptly after execution of the Settlement and License Agreement, which it has. Zimmer Biomet is also required to make additional payments to the Company on specified dates through January 15, 2021, for a total amount payable of $9.6 million, in consideration of the licenses, releases and other immunities granted by the Company to Zimmer Biomet. No payment is due from the Company to Zimmer Biomet.

The foregoing description is qualified in its entirety by reference to the text of the Settlement and License Agreement filed as exhibit 10.1 to the Current Report on Form 8-K filed on May 28, 2020.

On August 29, 2019, the Company filed a lawsuit against Medacta USA, Inc. (“Medacta”), in the United States District Court for the District of Delaware, and the Company amended its complaint on December 23, 2019, seeking damages for Medacta’s infringement of certain of the Company’s patents related to patient-specific instrument and implant systems. The Company alleges in the lawsuit that Medacta’s multiple lines of patient-specific instruments, as well as the implant components used in conjunction with them, infringe four of the Company’s patents. The accused product lines include Medacta patient-specific instrument and implant systems for knee and shoulder replacement procedures. On January 6, 2020, Medacta filed its answer, denying that its patient-specific instrument and implant systems infringe the patents asserted by the Company. Medacta’s answer also alleges the affirmative defense that the Company's asserted patents are invalid. Discovery in the lawsuit has commenced and is ongoing.

On March 20, 2020, Osteoplastics LLC ("Osteoplastics"), filed a lawsuit against the Company in the United States District Court for the District of Delaware, and Osteoplastics amended its complaint on April 2, 2020, alleging that the Company infringes seven patents owned by Osteoplastics. Osteoplastics alleges that the Company’s proprietary software, including the Company’s iFit software platform, and the Company’s use of its proprietary software for designing and manufacturing medical devices, including implants, infringes the seven asserted patents. On June 15, 2020, the Company filed a motion to dismiss Osteoplastics’ complaint. The court has not yet ruled on the motion to dismiss.
On April 24, 2020, the Company filed a lawsuit against Wright Medical Technology, Inc. and Tornier, Inc. (together, “Wright Medical”), in the United States District Court for the District of Delaware seeking damages for Wright Medical’s infringement of certain of the Company's patents related to patient-specific instrument and implant systems. The complaint alleges that Wright Medical’s multiple lines of patient-specific shoulder instruments, as well as the implant components used in conjunction with them, infringe four of the Company’s patents. The accused product lines include Wright Medical’s Tornier Blueprint™ 3D Planning + PSI shoulder replacement systems.
On May 8, 2020, the Company and an individual plaintiff filed a lawsuit against Aetna, Inc. and Aetna Life Insurance Company (together, “Aetna”) in the United States District Court for the District of Massachusetts seeking damages for Aetna’s improper denial of coverage for personalized knee implants under its health plans and the ones it administers. The complaint alleges that Aetna has violated its duties under state and federal law, including the Employee Retirement Income Security Act. On July 23, 2020, Aetna filed a motion to dismiss the complaint.  The court has not yet ruled on the motion to dismiss.

Adverse outcomes of these lawsuits could have a material adverse effect on the Company's business, financial condition or results of operations. The Company is presently unable to predict the outcome of these lawsuits or to reasonably estimate a range of potential losses, if any, related to the lawsuits.
Legal costs associated with legal proceedings are accrued as incurred.

Indemnification
 
In the normal course of business, the Company enters into contracts and agreements that contain a variety of representations and warranties and provide for general indemnifications. The Company’s exposure under these agreements is unknown because it involves claims that may be made against the Company in the future, but have not yet been made. To date, the Company has not paid any claims or been required to defend any action related to its indemnification obligations. However, the Company may record charges in the future as a result of these indemnification obligations. In accordance with its bylaws, the Company has indemnification obligations to its officers and directors for certain events or occurrences, subject to certain limits, while they are serving at the

22


Company’s request in such capacity. There have been no claims to date and the Company has a director and officer insurance policy that enables it to recover a portion of any amounts paid for future claims.

Note I—Debt and Notes Payable
 
Long-term debt consisted of the following (in thousands):
 
June 30,
2020
 
December 31,
2019
PPP "Term Loan"
4,720

 

Innovatus, Term Loan
20,000

 
20,000

Innovatus, Term Loan accrued payment-in-kind interest
516

 
262

Less unamortized debt issuance costs
(572
)
 
(639
)
Long-term debt, less debt issuance costs
$
24,664

 
$
19,623

    
Principal payments, including the Term Loan Basic Interest Rate in-kind (described below), due as of June 30, 2020 consisted of the following (in thousands):
 
Principal
Payment
2020 (remainder of the year)

2021

2022
4,720

2023
8,986

2024
12,580

Total
$
26,286


2017 Secured Loan Agreement
 
On January 6, 2017, the Company entered into the 2017 Secured Loan Agreement with Oxford. Through the 2017 Secured Loan Agreement, the Company accessed $15 million under Term Loan A at closing and an additional $15 million of borrowings under Term Loan B on June 30, 2017. On December 13, 2018, the Company entered into a fifth amendment (the "Fifth Amendment") to the 2017 Secured Loan Agreement, with Oxford, and pursuant to the Fifth Amendment, the Company pre-paid $15 million aggregate principal amount of the $30 million outstanding principal amount, as a pro rata portion of the Term A Loan and Term B Loan, together with accrued and unpaid interest thereon and a pro rata prepayment fee and final payment. Under the Fifth Amendment, the Company's cash collateral requirement was reduced to $5 million. On June 25, 2019, the Company elected to prepay the remainder of the Oxford term loan outstanding (along with accrued interest and applicable final payment and prepayment fee) using the proceeds from the 2019 Secured Loan Agreement. The prepayment of the debt was accounted for as a debt extinguishment and the Company incurred a loss on the extinguishment recognized in interest expense of $1.1 million.

2019 Secured Loan Agreement

On June 25, 2019, the Company entered into the 2019 Secured Loan Agreement with Innovatus, as collateral agent and lender, East West Bank and the Lenders, pursuant to which the Lenders agreed to make term loans and revolving credit facility to the Company to repay existing indebtedness, for working capital and general business purposes, in a principal amount of up to $30 million.

The term loan facility established under the 2019 Secured Loan Agreement is secured by substantially all of the Company's and its U.S. subsidiaries' properties, rights and assets.

The 2019 Secured Loan Agreement includes a trailing six months' revenue test, a liquidity covenant and an additional liquidity covenant that is applicable if there are borrowings under the revolving credit facility. The 2019 Secured Loan Agreement also includes customary representations, affirmative and negative covenants. Additionally, the 2019 Secured Loan Agreement includes events of default, the occurrence and continuation of which could cause interest to be charged at the rate that is otherwise applicable plus 5.0% and would provide

23


Innovatus, as collateral agent, with the right to accelerate all obligations under the 2019 Secured Loan Agreement and to exercise remedies against the Company and the collateral securing the credit facility, including foreclosure against assets securing the credit facilities, including the Company's cash.  These events of default include, among other things, the Company’s failure to pay any amounts due under the credit facility, a breach of covenants under the credit facility, the Company’s insolvency, a material adverse change, the occurrence of any default under certain other indebtedness in an amount greater than $250,000, one or more judgments against the Company in an amount greater than $500,000, changes with respect to governmental approvals and FDA actions.

On July 1, 2020, the Company entered into a Third Amendment to its Loan and Security Agreement, dated as of June 25, 2019. The Amendment, among other things, waives the trailing six-month revenue covenant milestones that apply to the quarters ending June 30, September 30 and December 31, 2020 under the Loan Agreement, and reduces the revenue covenant milestones that apply thereafter, delays until June 25, 2021 the Company’s option to prepay all, but not less than all, of the term loans advanced under the Loan Agreement and includes a new covenant that the Company raise additional capital. The Amendment also increases the Company’s minimum cash covenant to $5.0 million until December 31, 2020, provided that such minimum cash covenant shall be increased to $10.0 million, commencing on January 1, 2021, if the Company has not yet satisfied the new covenant relating to raising capital. The capital raise covenant in the Amendment specifies that on or before December 31, 2020, the Company shall receive aggregate gross cash proceeds of not less than $20.0 million from (i) the sale and issuance of the Company's equity securities (including, without limitation, by means of ATM offerings, private placements, follow on public offerings), (ii) net payments received from any of patent infringement disputes with Zimmer Biomet on or after July 1, 2020 and on or before December 31 2020, (iii) net payments received from any of the Company's other patent infringement disputes with any other party not specified in clause (ii), (iv) monetization of R&D tax credits or NOLs as part of any current or future 2020 government stimulus packages, or (v) governmental grants that are not (in whole or in part) in the form of indebtedness, or any combination of two or more of the foregoing. If the capital raise event has not occurred by December 31, 2020 and if the Company is in compliance with its revenue covenant milestones as of January 1, 2021, the period to comply with capital raise covenant will automatically extend to June 30, 2021. During the capital raise event extension period (i) commencing on January 1, 2021 and ending on (and including) March 31, 2021, the Company shall not have any indebtedness outstanding under the revolving line in excess of $2.5 million and (ii) commencing on April 1, 2021 and ending on (and including) June 30, 2021, the Company shall not have any indebtedness outstanding under the revolving line in excess of $5.0 million.

As of June 30, 2020, the Company was not in breach of covenants under the 2019 Secured Loan Agreement.

Term Loan - Innovatus

The term loan under the 2019 Secured Loan Agreement bears interest at a floating annual rate calculated at the greater of the variable rate of interest as most recently announced by East West Bank as prime or 5.50%, plus 3.75% ("Term Loan Basic Interest Rate"), bearing an effective interest rate of 9.25% at June 30, 2020. The Company is required to make interest only payments in arrears on the term loan for four years; provided that the Company has elected to pay 2.50% per annum as such Term Loan Basic Interest Rate in-kind by adding an amount equal to 2.50% per annum of the outstanding principal amount to the then outstanding principal balance on a monthly basis until the third anniversary of the 2019 Secured Loan Agreement. Commencing July 1, 2023, and continuing on the payment date of each month thereafter, the Company is required to make consecutive equal monthly payments of principal of the term loan, together with accrued interest, in arrears, to the Lenders.  All unpaid principal, accrued and unpaid interest with respect to the term loan, and a final fee in the amount of 5.0% of the term loan commitment, is due and payable in full on the term loan maturity date on June 1, 2024.

At the Company’s option, the Company may prepay all, but not less than all, of the term loans advanced by the Lenders under the term loan facility after the second year, subject to a prepayment fee and an amount equal to the sum of all outstanding principal of the term loans plus accrued and unpaid interest thereon through the prepayment date, a final fee, plus all other amounts that are due and payable, including the Lenders' expenses and interest at the default rate with respect to any past due amounts.

Revolving Credit Facility - East West Bank

Under the 2019 Secured Loan Agreement, East West Bank will make loans of up to $10 million from time to time outstanding, subject to availability based on a borrowing base equal to (i) 85.00% of eligible customer

24


accounts, subject to a maximum of 2.50% dilution based upon collections, minus (ii) the Company’s foreign accounts receivable credit insurance’s outstanding co-payment and minimum annual deductible (that has not been used at the applicable time). Advances under the revolving credit facility bear interest at a rate of 0.50% above the greater of East West Bank’s prime rate or 5.50%. Interest on the revolving advances is payable monthly in arrears. The revolving credit facility terminates and the principal and all amounts are due in full on June 25, 2024, provided that if an optional or mandatory prepayment (other than regularly scheduled payments) is made under the term loan, the Company must satisfy in full the obligations under the revolving credit line. The revolving credit facility requires a lockbox arrangement, which provides for all receipts to be swept daily to reduce the borrowings outstanding under the revolving credit facility.

There were no amounts outstanding under the revolving credit facility at June 30, 2020.

PPP Loan- East West Bank

On April 17, 2020, the Company entered into an approximately $4.7 million promissory note (the “PPP Note”) with East West Bank under the Paycheck Protection Program (“PPP”) offered by the U.S. Small Business Administration (the "SBA") to mitigate the negative financial and operational impacts of the coronavirus (COVID-19) pandemic. The interest rate on the PPP Note is a fixed rate of 1%per annum. The Company is required to make one payment of all outstanding principal plus all accrued unpaid interest on April 9, 2022 (the “Maturity Date”). The Company will pay regular monthly payments in an amount equal to one month’s accrued interest commencing on February 9, 2021, with all subsequent interest payments to be due on the same day of each month after that. All interest which accrues during the initial 10 months of the loan period will be deferred to and payable on the Maturity Date. According to the terms of the PPP, all or a portion of the loan may be fully forgiven if the funds are used for payroll costs (and at least 60% of the forgiven amount must have been used for payroll), interest on certain other outstanding debt, rent, and utilities. In accordance with the CARES Act, the Company intends to use the proceeds of the loan primarily for payroll costs. The Company accounts for the PPP Note as a debt instrument in accordance with ASC 470-50-40-2, with the proceeds from the loan recognize as a long-term liability, less any debt issuance costs, within the consolidated balance sheet. Interest is accrued at the stated rate on a monthly basis by applying the interest method under ASC 835.



Note J—Stockholders’ Equity
 
Common stock
 
Common stockholders are entitled to dividends as and when declared by the board of directors, subject to the rights of holders of all classes of stock outstanding having priority rights as to dividends. There have been no dividends declared to date.

    
Preferred stock

The Company’s Restated Certificate of Incorporation authorizes the Company to issue 5,000,000 shares of preferred stock, $0.00001 par value, all of which is undesignated. No shares were issued and outstanding at June 30, 2020 and December 31, 2019.


Demand registration rights

In conjunction with the Private Placement, on June 25, 2019, the Company entered into a registration rights agreement (the "Registration Rights Agreement"), with Innovatus, Innovatus Life Science Offshore Fund I, LP and Innovatus Life Sciences Offshore Fund I-A, LP (collectively, the "Innovatus Investors"), pursuant to which the Company agreed to register for resale the shares held by the Innovatus Investors (the “Shares”) under certain circumstances. Under the Registration Rights Agreement, in the event that the Company receives a written request from the Innovatus Investors that the Company file with the SEC a registration statement covering the resale of all of the Shares, the Company shall promptly but no later than 120 days after the date of such request prepare and file with the SEC such registration statement. The Innovatus Investors have agreed to use best efforts not to make

25


such a request, including by effecting any planned sales of Shares under Rule 144 under the Securities Act. The Company has agreed to use commercially reasonable efforts to cause such registration statement to become effective and to keep such registration statement effective until the date the Shares covered by such registration statement have been sold or may be resold pursuant to Rule 144 without restriction. The Company has agreed to be responsible for all fees and expenses incurred in connection with the registration of the Shares. The Company has granted the Innovatus Investors customary indemnification rights in connection with the registration statement. The Innovatus Investors have also granted the Company customary indemnification rights in connection with the registration statement.

Warrants
 
The Company also issued warrants to certain investors and consultants to purchase shares of the Company’s preferred stock and common stock. Based on the Company’s assessment of the warrants granted in 2013 and 2014 relative to ASC 480, Distinguishing Liabilities from Equity, the warrants are classified as equity. No warrants were issued in the three and six months ended June 30, 2020. According to ASC 480, an entity shall classify as a liability any financial instrument, other than an outstanding share, that, at inception, both a) embodies an obligation to repurchase the issuer’s equity shares, or is indexed to such obligation and b) requires or may require the issuer to settle the obligation by transferring assets. The warrants do not contain any provision that requires the Company to repurchase the shares and are not indexed to such an obligation. The warrants also do not require the Company to settle by transferring assets. All warrants were exercisable immediately upon issuance.

Common stock warrants
 
The Company also issued warrants to certain investors and consultants to purchase shares of common stock.  Warrants to purchase 28,926 shares of common stock were outstanding as of June 30, 2020 and December 31, 2019. Outstanding warrants are currently exercisable with varying exercise expiration dates from 2020 through 2024. At June 30, 2020 and December 31, 2019, the weighted average warrant exercise price per share for common stock underlying warrants and the weighted average contractual life was as follows:
 
 
Number of
Warrants
 
Weighted
Average
Exercise Price
Per Share
 
Weighted Average Remaining Contractual Life
 
Number of
Warrants
Exercisable
 
Weighted
Average Price
Per Share
 
 
 
 
 
 
 
 
 
 
 
Outstanding December 31, 2019
 
28,926

 
$
9.80

 
3.66
 
28,926

 
$
9.80

Outstanding June 30, 2020
 
28,926

 
$
9.80

 
3.16
 
28,926

 
$
9.80


Stock option plans

As of June 30, 2020, 300,869 shares of common stock were available for future issuance under the 2015 Stock Incentive Plan ("2015 Plan"). The 2015 Plan provides for an annual increase, to be added on the first day of each fiscal year, beginning with the fiscal year ending December 31, 2016 and continuing until, and including, the fiscal year ending December 31, 2025, equal to the lesser of (a) 3,000,000 shares of the Company's common stock, (b) 3% of the number of share of its common stock outstanding on the first day of such fiscal year and (c) an amount determined by the Board. Effective January 1, 2020, an additional 2,112,822 shares of the Company's common stock were added to the 2015 Plan under the terms of this provision.
    
On April 29, 2019, the stockholders approved the Conformis, Inc. 2019 Sales Team Performance-Based Equity Incentive Plan ("2019 Sales Team Plan") for up to 3,000,000 shares of common stock available to grant to certain sales representatives or independent sales agents. The 2019 Sales Team Plan provides for the grant of performance-based equity, including incentive stock options, nonstatutory stock options, stock appreciation rights, restricted stock awards, restricted stock units and other stock-based awards. Shares covered by awards under the 2019 Sales Team Plan that expire or are terminated, surrendered, or cancelled without having been fully exercised or are forfeited in whole or in part (including as the result of shares subject to such award being repurchased by us at the original issuance price pursuant to a contractual repurchase right) or that result in any shares not being issued, will again be available for the grant of awards under the 2019 Sales Team Plan. Equity granted under the 2019 Sales Team Plan will expire ten years from the date of grant.


26


As of June 30, 2020, 2,756,481 shares of common stock were available for future issuance under the 2019 Sales Team Plan.
    
Activity under all stock option plans was as follows:
 
 
Number of
Options
 
Weighted
Average
Exercise Price
per Share
 
Aggregate Intrinsic Value (in Thousands)
Outstanding December 31, 2019
 
1,802,463

 
$
6.75

 
 
Granted
 
191,667

 
0.98

 
 
Expired
 
(351,938
)
 
7.91

 
 
Outstanding June 30, 2020
 
1,642,192

 
$
5.83

 
$

Total vested and exercisable
 
1,269,509

 
$
6.75

 
$

     
The total fair value of stock options that vested during the three and six months ended June 30, 2020 was $0.1 million and $0.2 million. The weighted average remaining contractual term for the total stock options outstanding was 5.01 years as of June 30, 2020. The weighted average remaining contractual term for the total stock options vested and exercisable was 3.94 years as of June 30, 2020.

Restricted common stock award activity under the plan was as follows:
 
 
Number of Shares
 
Weighted Average Fair Value
Unvested December 31, 2019
 
4,436,928

 
$
1.54

Granted
 
3,927,355

 
0.98

Vested
 
(1,148,503
)
 
1.57

Forfeited
 
(191,193
)
 
1.25

Unvested June 30, 2020
 
7,024,587

 
$
1.24


The total fair value of restricted common stock awards that vested during the three and six months ended June 30, 2020 was $1.4 million and $1.8 million.

Inducement Awards
 
In February 2020, the Company granted inducement awards outside of the prior plans to the Company's Chief Financial Officer in the form of an option to purchase 125,000 shares of the Company's common stock with an exercise price per share equal to $0.98 and 125,000 restricted stock units and to the Company's Senior Vice President, Operations in the form of an option to purchase 66,667 shares of the Company's common stock with an exercise price per share equal to $0.98 and 61,350 restricted stock units. The option and restricted stock unit awards were granted as inducements material to their commencement of employment with the Company in accordance with Nasdaq Listing Rule 5635(c)(4).

Stock-based compensation
 
The Company uses the Black-Scholes option pricing model to determine the fair value of stock options. The determination of the fair value of stock-based payment awards on the date of grant using a pricing model is affected by the value of the Company’s common stock as well as assumptions regarding a number of complex and subjective variables. The valuation of the Company’s common stock prior to the IPO was performed with the assistance of an independent third-party valuation firm using a methodology that includes various inputs including the Company’s historical and projected financial results, peer company public data and market metrics, such as risk-free interest and discount rates. As the valuations included unobservable inputs that were primarily based on the Company’s own assumptions, the inputs were considered level 3 inputs within the fair value hierarchy.
    

27


The fair value of options at date of grant was estimated using the Black-Scholes option pricing model, based on the following assumptions:

 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Risk-free interest rate
 
N/A
 
N/A
 
1.539%
 
N/A
Expected term (in years)
 
N/A
 
N/A
 
6.25
 
N/A
Dividend yield
 
N/A
 
N/A
 
—%
 
N/A
Expected volatility
 
N/A
 
N/A
 
55.92%
 
N/A

Risk-free interest rate.    The risk-free interest rate is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options.
Expected term.    The expected term of stock options represents the period the stock options are expected to remain outstanding and is based on the “SEC Shortcut Approach” as defined in “Share-Based Payment” (SAB 107) ASC 718-10-S99, “Compensation-Stock Compensation-Overall-SEC Materials,” which is the midpoint between the vesting date and the end of the contractual term. With certain stock option grants, the exercise price may exceed the fair value of the common stock. In these instances, the Company adjusts the expected term accordingly.
Dividend yield.    The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation model.
Expected volatility.    Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period. The Company does not have sufficient history of market prices of its common stock as it is a newly public company. Therefore, the Company estimates volatility using historical volatilities of similar public entities.
Forfeitures.    The Company recognizes forfeitures as they occur.
Stock-based compensation expense was $0.8 million and $1.0 million for the three months ended June 30, 2020 and 2019, respectively and $1.6 million and $2.1 million for the six months ended June 30, 2020 and 2019, respectively. Stock-based compensation expense was calculated based on awards ultimately expected to vest. To date, the amount of stock-based compensation capitalized as part of inventory was not material.
 
The following is a summary of stock-based compensation expense (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Cost of revenues
 
$
2

 
$
133

 
$
14

 
$
299

Sales and marketing
 
116

 
49

 
228

 
130

Research and development
 
180

 
201

 
314

 
458

General and administrative
 
546

 
575

 
1,055

 
1,219

 
 
$
844

 
$
958

 
$
1,611

 
$
2,106


As of June 30, 2020, the Company had $0.4 million of total unrecognized compensation expense for options that will be recognized over a weighted average period of 2.47 years. As of June 30, 2020, the Company had $7.3 million of total unrecognized compensation expense for restricted awards that will be recognized over a weighted average period of 2.76 years.

Note K—Segment and Geographic Data
 
The Company operates as one reportable segment as described in Note B to the Consolidated Financial Statements. The countries in which the Company has local revenue generating operations have been combined into the following geographic areas: the United States (including Puerto Rico), Germany and the rest of world, which consists of Europe predominately (including the United Kingdom) and other foreign countries. Sales are attributable to a geographic area based upon the customer’s country of domicile. Net property, plant and equipment are based upon physical location of the assets.
 

28


Geographic information consisted of the following (in thousands):
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2020
 
2019
 
2020
 
2019
Product revenue
 
 

 
 

 
 

 
 

United States
 
$
8,331

 
$
17,194

 
$
22,159

 
$
34,793

Germany
 
1,346

 
1,673

 
3,316

 
4,137

Rest of world
 
66

 
470

 
558

 
876

 
 
$
9,743

 
$
19,337

 
$
26,033

 
$
39,806


 
 
June 30, 2020
 
December 31, 2019
Property and equipment, net
 
 

 
 

United States
 
$
13,709

 
$
13,303

Germany
 
46

 
53

 
 
$
13,755

 
$
13,356


29




ITEM 2.      MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
 
The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our consolidated financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2019. Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report on Form 10-Q, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties. As a result of many factors, including those factors set forth in the ‘‘Risk Factors’’ section of our Annual Report on Form 10-K for the fiscal year ended December 31, 2019, our actual results could differ materially from the results described, in or implied, by these forward-looking statements.

Forward-Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. All statements, other than statements of historical facts, contained in this Quarterly Report on Form 10-Q, including statements regarding our strategy, future operations, future financial position, future revenue, projected costs, prospects, our ability to raise additional funds, plans and objectives of management, effects of pandemics or other widespread health problems such as the ongoing COVID-19 pandemic on our business, and expected market growth are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.
The words “anticipate,” “believe,” “continue,” “could,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “potential,” “predict,” “project,” “should,” “target,” “will,” or “would” or the negative of these terms or other similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words.
These forward-looking statements include, among other things, statements about:

our estimates regarding the potential market opportunity and timing of estimated commercialization for our current and future products, including our iUni, iDuo, iTotal CR, iTotal PS, iTotal Identity, Conformis Hip System, and the planned launch of a new knee replacement offering to be targeted at hospital outpatient and ambulatory surgery centers;
our expectations regarding our sales, expenses, gross margin and other results of operations;
our strategies for growth and sources of new sales;
maintaining and expanding our customer base and our relationships with our independent sales representatives and distributors;
our current and future products and plans to promote them;
the anticipated trends and challenges in our business and in the markets in which we operate;
the implementation of our business model, strategic plans for our business, products, product candidates and technology;
our ability to achieve anticipated milestones under our collaborations;
our ability to successfully develop and commercialize planned products;
the future availability of raw materials used to manufacture, and finished components for, our products from third-party suppliers, including single source suppliers;
product liability claims;
patent infringement claims;
our ability to retain and hire necessary employees and to staff our operations appropriately;
our ability to compete in our industry and with innovations by our competitors;
potential reductions in reimbursement levels by third-party payors and cost containment efforts of accountable care organizations;

30


our ability to obtain reimbursement or direct payment for our products and services;
our ability to protect proprietary technology and other intellectual property and potential claims against us for infringement of the intellectual property rights of third parties;
potential challenges relating to changes in and compliance with governmental laws and regulations affecting our U.S. and international businesses, including regulations of the U.S. Food and Drug Administration and foreign government regulators, such as more stringent requirements for regulatory clearance of our products;
the anticipated adequacy of our capital resources to meet the needs of our business or our ability to raise any additional capital;
anticipated negative impacts related to the COVID-19 pandemic and the actions that we have taken and are planning in response, including our ability to continue production, the reliability of our supply chain, our ability to meet obligations under our loan agreements, the duration of decreased demand for our products, and whether or when the demand for procedures will increase;
our ability to continue as a going concern; and
our expectations regarding the time during which we will be an emerging growth company under the JOBS Act.
We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in this Quarterly Report on Form 10-Q, particularly in the “Risk Factors” section, that could cause actual results or events to differ materially from the forward-looking statements that we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, collaborations, joint ventures or investments that we may make or enter into.
You should read this Quarterly Report on Form 10-Q and the documents that we have filed as exhibits to this Quarterly Report on Form 10-Q and our other filings with the SEC completely and with the understanding that our actual future results may be materially different from what we expect. We do not assume any obligation to update any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Trademarks

Solely for convenience, our trademarks and trade names in this report are referred to without the ® and ™ symbols, but such references should not be construed as any indicator that we will not assert, to the fullest extent under applicable law, our rights thereto.


31


Overview
 
We are a medical technology company that uses our proprietary iFit Image-to-Implant technology platform to develop, manufacture and sell joint replacement implants and instruments that are individually sized and shaped, which we refer to as personalized, individualized, or sometimes as customized, to fit each patient’s unique anatomy. The worldwide market for joint replacement products is approximately $19.5 billion annually and growing, and we believe our iFit technology platform is applicable to all major joints in this market. We offer a broad line of personalized knee implants and instruments designed to restore the natural shape of a patient’s knee. As of December 31, 2019, we have sold a total of more than 110,000 knee implants, including more than 87,000 total knee implants and 22,000 partial knee implants. In multiple clinical studies, iTotal CR, our cruciate-retaining total knee replacement implant and best-selling product, demonstrated superior clinical outcomes, including better function, including kinematics and objective functional measures, and greater patient satisfaction compared to those of standard, or “off-the-shelf,” implants that it was tested against. In 2016, we initiated the broad commercial launch of the iTotal PS, our posterior-stabilized total knee replacement implant which addresses the largest segment of the knee replacement market. In July 2018, our first Conformis Hip Systems were implanted in a limited commercial launch. On November 11, 2019, we entered full commercial launch of the Conformis Hip System. We are planning for a limited commercial launch of a second stem for the Conformis Hip System in the first half of 2022. In the second half of 2021, we plan to launch a new knee replacement offering targeted at hospital outpatient and ambulatory surgery centers in the United States. In the first half of 2021, we are planning for a limited commercial launch of our cementless or Press Fit option for our iTotal Identity knee implant with the full commercial launch planned for the first half of 2022.
 
Our iFit technology platform comprises three key elements:
 
iFit Design, our proprietary algorithms and computer software that we use to design personalized implants and associated single-use patient-specific instrumentation, which we refer to as iJigs, based on computed tomography, or CT scans of the patient and to prepare a surgical plan personalized for the patient that we call iView.
iFit Printing, a three-dimensional, or 3D, printing technology that we use to manufacture iJigs and that we may extend to manufacture certain components of our personalized hip and knee replacement implants.
iFit Just-in-Time Delivery, our just-in-time manufacturing and delivery capabilities.
 
We believe our iFit technology platform enables a scalable business model that greatly lowers our inventory requirements, reduces the amount of working capital required to support our operations and allows us to launch new products and product improvements more rapidly, as compared to manufacturers of off-the-shelf implants. Manufacturers of traditional knee replacement implants offer products with a limited range of sizes and geometries, which we refer to as off-the-shelf implants. Off-the-shelf implants are not designed to restore a particular patient's unique anatomy.

     All of our joint replacement products have been cleared by the FDA under the premarket notification process of Section 510(k) of the Federal Food, Drug, and Cosmetic Act, or the FDCA, and all of our knee replacement products have received certification to CE Mark. We market our products to orthopedic surgeons, hospitals and other medical facilities and patients. We use direct sales representatives, independent sales representatives and distributors to market and sell our products in the United States, Germany, the United Kingdom and other markets.

We were incorporated in Delaware and commenced operations in 2004.

Components of our results of operations
 
The following is a description of factors that may influence our results of operations, including significant trends and challenges that we believe are important to an understanding of our business and results of operations.
 
Revenue
 
Our product revenue is generated from sales to hospitals and other medical facilities that are served through a direct sales force, independent sales representatives and distributors in the United States, Germany, the United Kingdom, Austria, Ireland, Switzerland, Singapore, Hong Kong, Malaysia, Monaco, Hungary, Spain,

32


Australia, Argentina, Benelux, United Arab Emirates, Italy and other markets. In order for surgeons to use our products, the medical facilities where these surgeons treat patients typically require us to enter into pricing agreements. The process of negotiating a pricing agreement can be lengthy and time-consuming, require extensive management time and may not be successful.
 
Revenue from sales of our products fluctuates principally based on the selling price of the joint replacement product, as the sales price of our products varies among hospitals and other medical facilities. In addition, our product revenue may fluctuate based on the product sales mix and mix of sales by geography. Our product revenue from international sales can be significantly impacted by fluctuations in foreign currency exchange rates, as our sales are denominated in the local currency in the countries in which we sell our products. We expect our product revenue to fluctuate from quarter-to-quarter due to a variety of factors, including seasonality, as we have historically experienced lower sales in the summer months and higher sales around year-end, the timing of the introduction of our new products, if any, and the impact of the buying patterns and implant volumes of medical facilities.

Royalty and licensing revenue for the three months ended June 30, 2020 includes revenue of $9.6 million generated from our settlement with Zimmer Biomet for a royalty-free, non-exclusive, worldwide license to certain patents for the exploitation of patient-specific or partially patient-specific instrumentation for knee, shoulder or hip replacement and releases and other immunities. Under ASC 606, these individual rights are accounted for as a single performance obligation. The earnings process is complete and revenue is recognized upon the execution of the contract, when collectability is probable and all other revenue recognition criteria have been met. Ongoing royalty revenue is also generated from our agreement with MicroPort Orthopedics Inc., a wholly owned subsidiary of MicroPort Scientific Corporation.

In December 2019, a human infection originating in China was traced to a novel strain of coronavirus. The virus subsequently spread to other parts of the world, including the United States and Europe, and caused unprecedented disruptions in the global economy as efforts to contain the spread of the virus intensified. In March 2020, the World Health Organization declared this coronavirus outbreak (COVID-19) a pandemic. The future progression of the pandemic and its effects on our business and operations are highly uncertain. We have experienced significantly decreased demand for our products and expect further unpredictable and potentially significant reductions in demand for our products as healthcare providers and individuals continue to de-prioritize and defer medical procedures that are deemed to be elective, such as joint replacement procedures, which has had and will continue to have a material adverse effect on our business, operations and financial condition.

On March 20, 2020, we provided notice to our employees of a furlough of approximately 80 employees effective as of March 23, 2020 to help address decreased demand for our products. The furlough resulted in limited production capacity at our manufacturing facilities, but sufficient to meet demand. While we have not experienced and do not currently anticipate significant interruptions in our supply chain, extended or additional quarantines, travel restrictions and other measures may significantly impact the ability of employees of our third-party suppliers to get to their places of work to manufacture the key components and materials necessary for our products. We have experienced and may experience further shortages of mask and gown consumables used in our clean room processes, which may further limit our production capacity and further delay the joint replacement procedures in which our products are used. Any delay or shortage of such components or materials or delays in delivering our products may result in our inability to satisfy consumer demand for our products in a timely manner or at all, which could harm our reputation, future sales, profitability and financial condition. On April 17, 2020, we entered into an approximately $4.7 million promissory note, or the PPP Note, with East West Bank under the Paycheck Protection Program, or the PPP offered by the U.S. Small Business Administration, or the SBA, to mitigate the negative financial and operational impacts of the pandemic. On April 23, 2020, we accelerated a plan to return to full-time employment the vast majority of those employees who were furloughed on March 23, 2020.

We provide certain information regarding our financial results or projected financial results on a non-GAAP "constant currency basis." This information estimates the impact of changes in foreign currency rates on the translation of our current or projected future period financial results as compared to the applicable comparable period. This impact is derived by taking the adjusted current or projected local currency results and translating them into U.S. Dollars based upon the foreign currency exchange rates for the applicable comparable period. It does not include any other effect of changes in foreign currency rates on our results or business. Non-GAAP information is not a substitute for, and is not superior to, information presented on a GAAP basis.


33


This non-GAAP financial measure may be different from non-GAAP financial measures used by other companies, limiting its usefulness for comparison purposes. Moreover, presentation of revenue on a constant currency basis is provided for year-over-year comparison purposes, and investors should be cautioned that the effect of changing foreign currency exchange rates has an actual effect on our operating results. We consider the use of a period over period revenue comparison on a constant currency basis to be helpful to investors, as it provides a revenue growth measure free of positive or negative volatility due to currency fluctuations.

Cost of revenue
 
We produce our computer aided designs, or CAD, in-house and in India and use them to direct most of our product manufacturing efforts. We manufacture all of our patient-specific instruments, or iJigs, tibial trays used in our total knee implants, and polyethylene tibia tray inserts for our iTotal CR and our iTotal PS product, in our facility in Wilmington, Massachusetts. We polish our femoral implants used in our total and partial knee products in our facility in Wallingford, Connecticut. Starting in 2019, we began to manufacture the lateral partial tibial tray components in our facility in Wilmington, Massachusetts. We outsource the production of the remainder of the partial knee tibial components, femoral castings, and other knee and hip components to third-party suppliers. Our suppliers make our personalized implant components using the CAD designs we supply. Cost of revenue consists primarily of costs of raw materials, manufacturing personnel, outsourced CAD labor, manufacturing supplies, inbound freight, manufacturing overhead, and depreciation expense. Also included in cost of revenue for the three months ended June 30, 2020, are legal fees payable to external counsel in connection with our patent licensing and enforcement activities related to the Settlement and License Agreement with Zimmer Biomet.
 
We calculate gross margin as revenue less cost of revenue divided by revenue. Our gross margin has been and will continue to be affected by a variety of factors, including primarily volume of units produced, mix of product components manufactured by us versus sourced from third parties, our average selling price, foreign exchange rates, the geographic mix of sales, product sales mix, the number of cancelled sales orders resulting in wasted implants, and royalty revenue.
 
We expect our gross margin from the sale of our products, which excludes royalty and licensing revenue, to expand over time to the extent we are successful in continuing to reduce our manufacturing costs per unit and increasing our manufacturing efficiency as sales volume increases. We believe that areas of opportunity to expand our gross margin in the future, if and as the volume of our product sales increases, include the following:
 
absorbing overhead costs across a larger volume of product sales;
obtaining more favorable pricing for the materials used in the manufacture of our products;
obtaining more favorable pricing of certain components of our products manufactured for us by third parties;
increasing the proportion of certain components of our products that we manufacture in-house, which we believe we can manufacture at a lower unit cost than vendors we currently use; and
developing new versions of our software used in the design of our personalized joint replacement implants, which we believe will reduce costs associated with the design process.
     
We also continue to explore other opportunities to reduce our manufacturing costs. However, these and the above opportunities may not be realized. In addition, our gross margin may fluctuate from period to period.

Operating expenses
 
Our operating expenses consist of sales and marketing, research and development and general and administrative expenses. Personnel costs are the most significant component of operating expenses and consist of salaries, benefits, stock-based compensation, and sales commissions.
 

34


Sales and marketing.    Sales and marketing expense consists primarily of personnel costs, including salary, employee benefits and stock-based compensation for personnel employed in sales, marketing, customer service, market access, medical education and training, as well as investments in surgeon training programs, industry events and other promotional activities. In addition, our sales and marketing expense includes sales commissions and bonuses, generally based on a percentage of sales, to our sales managers, direct sales representatives and independent sales representatives. Recruiting, training and retaining productive sales representatives as well as educating surgeons about the benefits of our products are required to generate and grow revenue. We expect sales and marketing expense to increase as we build up our sales and support personnel and expand our marketing efforts. Our sales and marketing expense may fluctuate from period to period due to the seasonality of our revenue and the timing and extent of our expenses.

Research and development.    Research and development expense consists primarily of personnel costs, including salary, employee benefits and stock-based compensation for personnel employed in research and development, regulatory and clinical areas. Research and development expense also includes costs associated with product design, product refinement and improvement efforts before and after receipt of regulatory clearance, development of prototypes, testing, clinical study programs, regulatory activities, contractors, consultants, equipment, and software development. As our revenue increases, we will also incur additional expenses for revenue share payments to our past and present scientific advisory board members. We expect research and development expense to increase in absolute dollars as we develop new products to expand our product pipeline, add research and development personnel and conduct clinical activities.
 
General and administrative.    General and administrative expense consists primarily of personnel costs, including salary, employee benefits and stock-based compensation for our administrative personnel that support our general operations, including executive management, legal, finance and accounting, information technology and human resources personnel. General and administrative expense also includes outside legal costs associated with intellectual property and general legal matters, financial audit fees, insurance, fees for other consulting services, depreciation expense, freight, and facilities expense. We expect our general and administrative expense will increase in absolute dollars as we increase our headcount and expand our infrastructure to support growth in our business and our operations. As our revenue increases, we also incur additional expenses for freight. Our general and administrative expense may fluctuate from period to period due to the timing and extent of the expenses.
 
Total other income (expenses), net
 
Total other income (expenses), net consists primarily of interest expense and amortization of debt discount associated with our term loans outstanding during the year, debt extinguishment loss, and gains (losses) from foreign currency transactions. The effect of exchange rates on our foreign currency-denominated asset and liability balances are recorded as foreign currency transaction adjustments in the consolidated statements of comprehensive loss.

Income tax provision
 
Income tax provision consists primarily of a provision for income taxes in foreign jurisdictions in which we conduct business. We maintain a full valuation allowance for deferred tax assets including net operating loss carryforwards and research and development credits and other tax credits.

35


Consolidated results of operations
 
Comparison of the three months ended June 30, 2020 and 2019
 
The following table sets forth our results of operations expressed as dollar amounts, percentage of total revenue and year-over-year change (in thousands):
 
 
2020
 
2019
 
2020 vs 2019
Three Months Ended June 30,
 
Amount
 
As a% of
Total
Revenue
 
Amount
 
As a% of
Total
Revenue
 
$
Change
 
%
Change
Revenue
 
 

 
 

 
 

 
 

 
 

 
 

Product revenue
 
$
9,743

 
50
 %
 
$
19,337

 
99
 %
 
$
(9,594
)
 
(50
)%
Royalty and licensing
 
9,725

 
50

 
256

 
1

 
9,469

 
3,699

Total revenue
 
19,468

 
100

 
19,593

 
100

 
(125
)
 
(1
)
Cost of revenue
 
8,450

 
43

 
9,971

 
51

 
(1,521
)
 
(15
)
Gross profit
 
11,018

 
57

 
9,622

 
49

 
1,396

 
15

 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 

 
 

 
 

 
 

 
 

 
 

Sales and marketing
 
$
4,102

 
21
 %
 
$
6,897

 
35
 %
 
$
(2,795
)
 
(41
)%
Research and development
 
2,738

 
14

 
3,328

 
17

 
(590
)
 
(18
)
General and administrative
 
6,474

 
33

 
5,289

 
27

 
1,185

 
22

Total operating expenses
 
13,314

 
68

 
15,514

 
79

 
(2,200
)
 
(14
)
Loss from operations
 
(2,296
)
 
(12
)
 
(5,892
)
 
(30
)
 
3,596

 
61

Total other income (expenses), net
 
133

 
1

 
(848
)
 
(4
)
 
981

 
116

Loss before income taxes
 
(2,163
)
 
(11
)
 
(6,740
)
 
(34
)
 
4,577

 
68

Income tax provision
 
(28
)
 

 
23

 

 
(51
)
 
(222
)
Net loss
 
$
(2,135
)
 
(11
)%
 
$
(6,763
)
 
(35
)%
 
$
4,628

 
68
 %

Product revenue.    Product revenue was $9.7 million for the three months ended June 30, 2020 compared to $19.3 million for the three months ended June 30, 2019, a decrease of $9.6 million or 50%. We believe the decline is primarily due to the postponement of elective surgeries as a result of the COVID-19 pandemic.
 
The following table sets forth, for the periods indicated, our product revenue by geography expressed as U.S. dollar amounts, percentage of product revenue and year-over-year change (in thousands):
 
 
2020
 
2019
 
2020 vs 2019
Three Months Ended June 30,
 
Amount
 
As a % of
Product
Revenue
 
Amount
 
As a % of
Product
Revenue
 
$
Change
 
%
Change
United States
 
$
8,331

 
86
%
 
$
17,194

 
89
%
 
$
(8,863
)
 
(52
)%
Germany
 
1,346

 
14

 
1,673

 
9

 
(327
)
 
(20
)
Rest of world
 
66

 

 
470

 
2

 
(404
)
 
(86
)
Product revenue
 
$
9,743

 
100
%
 
$
19,337

 
100
%
 
$
(9,594
)
 
(50
)%
 
Product revenue in the United States was generated through our direct sales force and independent sales representatives. The percentage of product revenue generated in the United States was 86% for the three months ended June 30, 2020 compared to 89% for the three months ended June 30, 2019. We believe the lower level of revenue inside the United States as a percentage of product revenue in the three months ended June 30, 2020 was due to the postponement of elective surgeries due to the COVID-19 pandemic, the negative impact in the United

36


States for denials of coverage from Aetna, and the expansion of sales into additional countries. The impact of COVID-19 is affecting all geographies.

The United States product revenue decreased $8.9 million to $8.3 million or 52% year over year. Germany product revenue decreased $0.3 million to $1.3 million, or 20% year over year on a reported basis and 19% on a constant currency basis. Rest of World product revenue decreased $0.4 million to $0.1 million, or 86% year-over-year on a reported basis and 85% on a constant currency basis.


Royalty and licensing revenue. Royalty and licensing revenue was $9.7 million for the three months ended June 30, 2020 compared to $0.3 million for the three months ended June 30, 2019. The increase in royalty and licensing revenue was driven by $9.6 million in revenue recognized under the Settlement and License Agreement with Zimmer Biomet.

    Cost of revenue, gross profit and gross margin.    Cost of revenue was $8.5 million for the three months ended June 30, 2020 compared to $10.0 million for the three months ended June 30, 2019, a decrease of $1.5 million, or 15%. Gross profit was $11.0 million for the three months ended June 30, 2020 compared to $9.6 million for the three months ended June 30, 2019, an increase of $1.4 million or 15%. Gross margin increased 750 basis points to 57% for the three months ended June 30, 2020 from 49% for the three months ended June 30, 2019. The increase in gross margin was driven primarily by the Zimmer Biomet licensing revenue. Also included in cost of revenue are legal fees payable to external counsel in connection with alternative fee arrangements relating to patent licensing and enforcement activities related to the Zimmer Biomet settlement.
 
Sales and marketing.    Sales and marketing expense was $4.1 million for the three months ended June 30, 2020 compared to $6.9 million for the three months ended June 30, 2019, a decrease of $2.8 million or 41%. The decrease was due primarily to lower commission expense of $2.2 million in addition to $0.6 million of lower personnel, marketing and travel expenses. Sales and marketing expense as a percentage of total revenue was 21% for the three months ended June 30, 2020 compared to 35% for the three months ended June 30, 2019.

Research and development.    Research and development expense was $2.7 million for the three months ended June 30, 2020 compared to $3.3 million for the three months ended June 30, 2019, a decrease of $0.6 million, or 18%. The decrease was due primarily to lower revenue share expense of $0.4 million, a decrease in clinical trials and project related costs of $0.3 million, and $0.4 million of cost allocated to the advance on research and development. Personnel costs increased $0.6 million, which partially offset the decreases in expense. Research and development expense decreased as a percentage of total revenue to 14% for the three months ended June 30, 2020 from 17% for the three months ended June 30, 2019.
 
General and administrative.    General and administrative expense was $6.5 million for the three months ended June 30, 2020 compared to $5.3 million for the three months ended June 30, 2019, an increase of $1.2 million, or 22%. The increase was primarily due to higher legal fees of $0.5 million, personnel related costs of $0.5 million, severance of $0.1 million, and $0.1 million in other costs. General and administrative expense increased as a percentage of total revenue to 33% for the three months ended June 30, 2020 from 27% for the three months ended June 30, 2019.

Total other income (expenses), net.    Other income (expenses), net was $0.1 million for the three months ended June 30, 2020 compared to $(0.8) million for the three months ended June 30, 2019, a change of $1.0 million. The change was primarily due to a decrease in interest expense.

Income taxes.    Income tax provision was $(28,000) and $23,000 for the three months ended June 30, 2020 and 2019, respectively. We continue to generate losses for U.S. federal and state tax purposes and have net operating loss carryforwards creating a deferred tax asset. We maintain a full valuation allowance for deferred tax assets.
 



37


Comparison of the six months ended June 30, 2020 and 2019
 
The following table sets forth our results of operations expressed as dollar amounts, percentage of total revenue and year-over-year change (in thousands):
 
 
 
2020
 
2019
 
2020 vs 2019
Six Months Ended June 30,
 
Amount
 
As a%
of
Total
Revenue
 
Amount
 
As a%
 of
Total
Revenue
 
$
Change
 
%
Change
Revenue
 
 

 
 

 
 

 
 

 
 

 
 

Product revenue
 
$
26,033

 
72
 %
 
$
39,806

 
99
 %
 
$
(13,773
)
 
(35
)%
Royalty and licensing
 
9,910

 
28

 
431

 
1

 
9,479

 
2,199
 %
Total revenue
 
35,943

 
100

 
40,237

 
100

 
(4,294
)
 
(11
)%
Cost of revenue
 
17,711

 
49

 
20,784

 
52

 
(3,073
)
 
(15
)%
Gross profit
 
18,232

 
51

 
19,453

 
48

 
(1,221
)
 
(6
)%
 
 
 
 
 
 
 
 
 
 
 
 
 
Operating expenses:
 
 

 
 

 
 

 
 

 
 

 
 

Sales and marketing
 
$
10,665

 
30
 %
 
$
15,078

 
37
 %
 
$
(4,413
)
 
(29
)%
Research and development
 
5,728

 
16

 
6,240

 
16

 
(512
)
 
(8
)
General and administrative
 
12,210

 
34

 
10,618

 
26

 
1,592

 
15

Total operating expenses
 
28,603

 
80

 
31,936

 
79

 
(3,333
)
 
(10
)
Loss from operations
 
(10,371
)
 
(29
)
 
(12,483
)
 
(31
)
 
2,112

 
17

Total other income (expenses), net
 
(1,120
)
 
(3
)
 
(1,847
)
 
(5
)
 
727

 
39

Loss before income taxes
 
(11,491
)
 
(32
)
 
(14,330
)
 
(36
)
 
2,839

 
20

Income tax provision
 
(3
)
 

 
14

 

 
(17
)
 
(121
)
Net loss
 
$
(11,488
)
 
(32
)%
 
$
(14,344
)
 
(36
)%
 
$
2,856

 
20
 %

Product revenue.    Product revenue was $26.0 million for the six months ended June 30, 2020, compared to $39.8 million for the six months ended June 30, 2019, a decrease of $14 million or 35%. We believe the decline is primarily due to the postponement of elective surgeries as a result of the COVID-19 pandemic.
 
The following table sets forth, for the periods indicated, our product revenue by geography expressed as U.S. dollar amounts, percentage of product revenue and year-over-year change (in thousands):
 
 
 
2020
 
2019
 
2020 vs 2019
Six Months Ended June 30,
 
Amount
 
As a % of
Product
Revenue
 
Amount
 
As a % of
Product
Revenue
 
$
Change
 
%
Change
United States
 
$
22,159

 
85
%
 
$
34,793

 
88
%
 
$
(12,634
)
 
(36
)%
Germany
 
3,316

 
13

 
4,137

 
10

 
$
(821
)
 
(20
)
Rest of world
 
558

 
2

 
876

 
2

 
(318
)
 
(36
)
Product revenue
 
$
26,033

 
100
%
 
$
39,806

 
100
%
 
$
(13,773
)
 
(35
)%
 
Product revenue in the United States was generated through our direct sales force and independent sales representatives. Product revenue outside the United States was generated through our direct sales force and distributors. The percentage of product revenue generated in the United States was 85% for the six months ended June 30, 2020 compared to 88% for the six months ended June 30, 2019. We believe the lower level of revenue as a percentage of product revenue inside the United States in the six months ended June 30, 2020 was due to the postponement of elective surgeries due to the COVID-19 pandemic, the negative impact in the United States for

38


denials of coverage from Aetna, and the expansion of sales into additional countries. The impact of COVID-19 is affecting all geographies.
    
The United States product revenue decreased $12.6 million to $22.2 million or 36% year over year. Germany product revenue decreased $0.8 million to $3.3 million, or 20% year over year on a reported basis and 19% on a constant currency basis. Rest of World product revenue decreased $0.3 million to $0.6 million, or 36% year-over-year on a reported and constant currency basis.

Royalty and licensing revenue. Royalty and licensing revenue was $9.9 million for the six months ended June 30, 2020 and $0.4 million for the six months ended June 30, 2019, an increase of $9.5 million. The increase in royalty and licensing revenue was driven by $9.6 million in revenue recognized under the Settlement and License Agreement with Zimmer Biomet.
 
Cost of revenue, gross profit and gross margin.    Cost of revenue was $17.7 million for the six months ended June 30, 2020 compared to $20.8 million for the six months ended June 30, 2019, a decrease of $3.1 million, or 15%. Gross profit was $18.2 million for the six months ended June 30, 2020 compared to $19.5 million for the six months ended June 30, 2019, a decrease of $1.2 million or 6%. Gross margin increased 300 basis points to 51% for the six months ended June 30, 2020 from 48% for the six months ended June 30, 2019. This increase in gross margin was driven primarily by the $9.6 million licensing revenue as a result of the Settlement and License Agreement with Zimmer Biomet. Also included in cost of revenue are legal fees payable to external counsel in connection with alternative fee arrangements relating to patent licensing and enforcement activities related to the Zimmer Biomet settlement.
 
Sales and marketing.    Sales and marketing expense was $10.7 million for the six months ended June 30, 2020 compared to $15.1 million for the six months ended June 30, 2019, a decrease of $4.4 million, or 29%. The decrease was due primarily to lower commissions and other revenue based compensation expenses of $3.8 million, lower travel expenses of $0.4 million, and lower marketing program expenses of $0.2 million. The decrease was partially offset by an increase in reusable instrumentation depreciation of $0.3 million. Sales and marketing expense decreased as a percentage of total revenue to 30% for the six months ended June 30, 2020 compared to 37% for the six months ended June 30, 2019.

Research and development.    Research and development expense was $5.7 million for the six months ended June 30, 2020 compared to $6.2 million for the six months ended June 30, 2019, a decrease of $0.5 million, or 8%. The decrease was due to lower consulting and clinical trial expense of $0.4 million and $0.7 million of cost allocated to the advance on research and development, partially offset by an increase of $0.7 million in personnel costs. Research and development expense remained consistent as a percentage of total revenue at 16% for the six months ended June 30, 2020 and June 30, 2019.

General and administrative.    General and administrative expense was $12.2 million for the six months ended June 30, 2020 compared to $10.6 million for the six months ended June 30, 2019, an increase of $1.6 million, or 15%. The increase was primarily due to higher personnel costs of $0.6 million, legal expense of $0.4 million, professional service expense of $0.5 million, severance of $0.2 million, and insurance and recruiting expense of $0.3 million. These increases were partially offset by decreases in outbound freight costs of $0.3 million as a result of the lower revenue. General and administrative expense increased as a percentage of total revenue to 34% for the six months ended June 30, 2020 compared to 26% for the six months ended June 30, 2019.

     Total other income (expenses), net.    Other expenses were $1.1 million for the six months ended June 30, 2020 compared to $1.8 million for the six months ended June 30, 2019, a decrease of $0.7 million or 39%. The change was primarily due to lower interest expense of $0.6 million and a $0.2 million decrease in foreign currency exchange transaction expense.

Income taxes.    Income tax provision was approximately $(3,000) for the six months ended June 30, 2020 and $14,000 for the six months ended June 30, 2019. We continue to generate losses for U.S. federal and state tax purposes and have net operating loss carryforwards creating a deferred tax asset. We maintain a full valuation allowance for deferred tax assets.


Liquidity, capital resources and plan of operations
 

39


Sources of liquidity and funding requirements
 
From our inception in June 2004 through the six months ended June 30, 2020, we have financed our operations primarily through private placements of preferred stock, our initial public offering in 2015, other equity financings, debt and convertible debt financings, equipment purchase loans, patent licensing, and product revenue beginning in 2007. We have not yet attained profitability and continue to incur operating losses and negative operating cash flows, which adversely impacts our ability to continue as a going concern. As of June 30, 2020, we have an accumulated deficit of $515.6 million.
      
In January 2017, we filed a shelf registration statement on Form S-3, which was declared effective by the SEC on May 9, 2017, or the 2017 Shelf Registration Statement. The 2017 Shelf Registration Statement allows us to sell from time to time up to $200 million of common stock, preferred stock, debt securities, warrants, or units comprised of any combination of these securities, for our own account in one or more offerings. On May 10, 2017, we filed with the SEC a prospectus supplement, pursuant to which we could issue and sell up to $50 million of our common stock and entered into an Equity Distribution Agreement with Canaccord Genuity LLC (formerly
Canaccord Genuity Inc.) or Canaccord, pursuant to which Canaccord agreed to sell shares of our common stock from time to time, as our agent in an “at-the-market”, or ATM, offering as defined in Rule 415 promulgated under the U.S. Securities Act of 1933, as amended, or the Securities Act. We are not obligated to sell any number of shares under the Distribution Agreement. As of June 30, 2020, we had sold 2,610,112 shares under the Distribution Agreement resulting in net proceeds of $4.3 million. On August 4, 2020, we and Canaccord mutually agreed to terminate the Distribution Agreement, effective upon the filing of this Quarterly Report on Form 10-Q for the quarterly period ended June 30, 2020 with the SEC. As of August 4, 2020, we had sold 2,663,000 shares under the Distribution Agreement resulting in net proceeds of $4.4 million.

On March 23, 2020, we filed a new shelf registration statement on Form S-3 or the New Shelf Registration Statement. Under the New Shelf Registration Statement, we will be permitted to sell from time to time up to $200 million of common stock, preferred stock, debt securities, warrants, or units comprised of any combination of these securities, for its own account in one or more offerings. The New Shelf Registration Statement is intended to provide us flexibility to conduct sales of its registered securities, subject to market conditions and our future capital needs. The terms of any offering under the New Shelf Registration Statement will be established at the time of such offering and will be described in a prospectus supplement filed with the SEC prior to the completion of any such offering.

On August 5, 2020, we filed with the SEC a prospectus supplement, for the sale and issuance of up to $25 million of its common stock and entered into an at-the-market issuance sales agreement, or the Sales Agreement, with Cowen and Company, LLC, or Cowen, pursuant to which we may offer and sell shares of the our common stock to or through Cowen, acting as agent and/or principal, from time to time in an “at-the-market” offering as defined in Rule 415 promulgated under the Securities Act of 1933, as amended, including without limitation sales made by means of ordinary brokers’ transactions on the Nasdaq Global Select Market or otherwise at market prices prevailing at the time of sale, in block transactions, or as otherwise directed by us. Cowen will use commercially reasonable efforts to sell the Common Stock from time to time, based upon instructions from us (including any price, time or size limits or other customary parameters or conditions we may impose). We will pay Cowen a commission of up to 3.0% of the gross sales proceeds of any Common Stock sold through Cowen under the Sales Agreement, and also has provided Cowen with customary indemnification rights.

The shares of Common Stock being offered pursuant to the Sales Agreement will be offered and sold pursuant to the New Shelf Registration Statement. We are not obligated to make any sales of Common Stock under the Sales Agreement. The offering of shares of Common Stock pursuant to the Sales Agreement will terminate upon the earlier of (i) the sale of all Common Stock subject to the Sales Agreement or (ii) termination of the Sales Agreement in accordance with its terms.

40


On December 17, 2018, we entered into a stock purchase agreement, or the "Stock Purchase Agreement," with Lincoln Park Capital, or "LPC." Upon entering into the Stock Purchase Agreement, we sold 1,921,968 shares of common stock for $1.0 million to LPC, representing a premium of 110% to the previous day's closing price. As consideration for LPC’s commitment to purchase shares of common stock under the Stock Purchase Agreement, we issued 354,430 shares to LPC.  We have the right at our sole discretion to sell to LPC up to $20.0 million worth of shares over a 36-month period subject to the terms of the Stock Purchase Agreement. We will control the timing of any sales to LPC and LPC will be obligated to make purchases of our common stock upon receipt of requests from us in accordance with the terms of the Stock Purchase Agreement. There are no upper limits to the price per share LPC may pay to purchase the up to $20.0 million worth of common stock subject to the Stock Purchase Agreement, and the purchase price of the shares will be based on the then prevailing market prices of our shares at the time of each sale to LPC as described in the Stock Purchase Agreement, provided that LPC will not be obligated to make purchases of our common stock pursuant to receipt of a request from us on any business day on which the last closing trade price of our common stock on the Nasdaq Capital Market (or alternative national exchange in accordance with the Stock Purchase Agreement) is below a floor price of $0.25 per share No warrants, derivatives, financial or business covenants are associated with the Stock Purchase Agreement and LPC has agreed not to cause or engage in any manner whatsoever, any direct or indirect short selling or hedging of shares of our common stock.  The Stock Purchase Agreement may be terminated by us at any time, at our sole discretion, without any cost or penalty. As of June 30, 2020, we have sold 3,121,968 shares under the Stock Purchase Agreement resulting in proceeds of $2.3 million. As of August 4, 2020, we had sold 4,521,968 shares under the Stock Purchase Agreement resulting in proceeds of $3.4 million.

On June 25, 2019, we entered into a Loan and Security Agreement or the 2019 Secured Loan Agreement with Innovatus Life Sciences Lending Fund I, LP or Innovatus, as collateral agent and lender, East West Bank and the other lenders party thereto from time to time, or Lenders, pursuant to which the Lenders agreed to make term loans and a revolving credit facility to the Company to repay existing indebtedness, for working capital and general business purposes, in a principal amount of up to $30 million. We used the proceeds from the 2019 Secured Loan Agreement to pay off the $15 million term loan from Oxford Finance LLC. In addition, Innovatus purchased approximately $3 million of our common stock at the previous day's closing price. During the first quarter of 2020, we reported that we may not be able to meet our second quarter revenue covenant and would work with Innovatus with the goal of adjusting the revenue covenants under the 2019 Secured Loan Agreement. On July 1, 2020, we entered into a Third Amendment to our Loan and Security Agreement, dated as of June 25, 2019. The Amendment, among other things, waives the trailing six-month revenue covenant milestones that apply to the quarters ending June 30, September 30 and December 31, 2020 under the Loan Agreement and reduces the revenue covenant milestones that apply thereafter, delays until June 25, 2021 our option to prepay all, but not less than all, of the term loans advanced under the Loan Agreement and includes a new covenant that we raise additional capital. The Amendment also increases our minimum cash covenant to $5 million until December 31, 2020, provided that such minimum cash covenant shall be further increased to $10 million, commencing on January 1, 2021, if we have not yet satisfied the new covenant relating to raising capital. The capital raise covenant in the Amendment specifies that on or before December 31, 2020,we shall receive aggregate gross cash proceeds of not less than $20.0 million from (i) the sale and issuance of our equity securities (including, without limitation, by means of at-the-market (ATM) offering, private placements, follow on public offerings), (ii) net payments received from any of patent infringement disputes with Zimmer on or after July 1, 2020 and on or before December 31 2020, (iii) net payments received from any of our other patent infringement disputes with any other party not specified in clause (ii), (iv) monetization of R&D tax credits or NOLs as part of any current or future 2020 government stimulus packages, or (v) governmental grants that are not (in whole or in part) in the form of indebtedness, or any combination of two or more of the foregoing. If the capital raise event has not occurred by December 31, 2020 and if we are in compliance with our revenue covenant milestones as of January 1, 2021, the period to comply with capital raise covenant will automatically extend to June 30, 2021. During the capital raise event extension period (i) commencing on January 1, 2021 and ending on (and including) March 31, 2021, we shall not have any indebtedness outstanding under the revolving line in excess of $2.5 million and (ii) commencing on April 1, 2021 and ending on (and including) June 30, 2021, we shall not have any indebtedness outstanding under the revolving line in excess of $5.0 million. As of June 30, 2020, we were not in breach of covenants under the 2019 Secured Loan Agreement. For further information regarding the 2019 Secured Loan Agreement and the Amendment, see "Note I—Debt and Notes Payable " in the financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q.


41


On September 30, 2019, we entered into an Asset Purchase Agreement with Howmedica Osteonics Corp., a subsidiary of Stryker Corporation also known as Stryker Orthopaedics, or Stryker. In connection with entering into the Asset Purchase Agreement, we also entered into a Development Agreement, a License Agreement, and other ancillary agreements contemplated by the Asset Purchase Agreement with Stryker. Under the terms of the agreements, we agreed to sell and license to Stryker certain assets relating to the Company's patient-specific instrumentation technology, and to develop, manufacture, and supply patient-specific instrumentation for use in connection with Stryker's "off-the-shelf" non-personalized knee implant offerings. We received $14 million upfront and will receive up to an additional $16 million in milestone payments pursuant to the License Agreement and the Development Agreement. As of June 30, 2020, we successfully completed the first out of three milestones with Stryker and received $2.0 million for achievement of this milestone. Under the long-term Distribution Agreement, we will supply patient-specific instrumentation to Stryker. We may be required to pay back a portion of the initial payment as it is contingent on successful completion of milestones set forth in the Development Agreement and License Agreement.

The Coronavirus Aid, Relief, and Economic Security Act, or the CARES Act, was enacted on March 27, 2020 in the United States. On April 17, 2020, we entered into an approximately $4.7 million promissory note, or the PPP Note, with East West Bank as the lender under the PPP offered by the SBA, to mitigate the negative financial and operational impacts of the coronavirus (COVID-19) pandemic. The interest rate on the PPP Note is a fixed rate of 1% per annum. We are required to make one payment of all outstanding principal plus all accrued unpaid interest on April 9, 2022, or the Maturity Date. We will pay regular monthly payments in an amount equal to one month’s accrued interest commencing on February 9, 2021, with all subsequent interest payments to be due on the same day of each month after that. All interest which accrues during the initial 10 months of the loan period will be deferred to and payable on the Maturity Date. According to the terms of the PPP, all or a portion of the loan may be fully forgiven if the funds are used for payroll costs (and at least 60% of the forgiven amount must have been used for payroll), interest on certain other outstanding debt, rent, and utilities. In accordance with the CARES Act, we intend to use the proceeds of the loan primarily for payroll costs.

On May 22, 2020, we entered into a Settlement and License Agreement, or the Settlement and License Agreement, with Zimmer Biomet, Zimmer US, Inc. and Biomet Manufacturing, LLC, or collectively, Zimmer Biomet, pursuant to which the parties have agreed to terms for resolving their existing patent disputes. Under the Settlement and License Agreement, we and Zimmer Biomet agreed to dismiss both outstanding patent infringement lawsuits between the parties. Pursuant to the Settlement and License Agreement, we granted to Zimmer Biomet a royalty-free, non-exclusive, worldwide license to certain of our patents for Zimmer Biomet’s patient-specific instrumentation used with off-the-shelf knee, hip, and shoulder implants, and Zimmer Biomet granted us a fully paid-up, royalty-free, non-exclusive, worldwide license to certain Zimmer Biomet patents for our implants and patient-specific instruments for the knee. Zimmer Biomet was required to pay us $3.5 million promptly after execution of the Settlement and License Agreement, which it has. Zimmer Biomet is also required to make additional payments to us on specified dates through January 15, 2021, for a total amount payable of $9.6 million, in consideration of the licenses, releases and other immunities granted by us to Zimmer Biomet. No payment is due from us to Zimmer Biomet.
    
We expect to incur substantial expenditures in the foreseeable future in connection with the following:
expansion of our sales and marketing efforts;
expansion of our manufacturing capacity;
funding research, development and clinical activities related to our existing products and product platform, including iFit design software and product support;
funding research, development and clinical activities related to new products that we may develop, including other joint replacement products;
pursuing and maintaining appropriate regulatory clearances and approvals for our existing products and any new products that we may develop; and
preparing, filing and prosecuting patent applications, and maintaining and enforcing our intellectual property rights and position.

We anticipate that our principal sources of funds in the future will be revenue generated from the sales of our products, including the successful full commercial launch of the Conformis Hip System, successful completion of the development milestones set forth in the Development Agreement and License Agreement milestones,

42


potential payments from Stryker pursuant to the Distribution Agreement, available sales of shares under the Sales Agreement and the Stock Purchase Agreement, available borrowings under the revolving credit facility, potential future capital raises through the issuance of equity or other securities, debt financings, and revenues that we may generate in connection with licensing our intellectual property. Additionally, in order for us to meet our operating plan, gross margin improvements and operating expense reductions will be necessary to reduce cash used in operations. We will need to generate significant additional revenue to achieve and maintain profitability, and even if we achieve profitability, we cannot be sure that we will remain profitable for any substantial period of time. It is also possible that we may allocate significant amounts of capital toward products or technologies for which market demand is lower than anticipated and, as a result, abandon such efforts. If we are unable to obtain adequate financing or financing on terms satisfactory to us when we require it, or if we expend capital on projects that are not successful, our ability to continue to support our business growth and to respond to business challenges could be significantly limited, and we may even have to scale back our operations. Our failure to become and remain profitable could impair our ability to raise capital, expand our business, maintain our research and development efforts or continue to fund our operations.

Our consolidated financial statements have been prepared assuming that we will continue as a going concern, which contemplates the realization of assets and the settlement of liabilities and commitments in the normal course of business. Uncertainties related to the COVID-19 pandemic, the timing of completion of the milestones set forth in the Stryker Agreement, and our ability to raise capital, raise substantial doubt in our ability to continue as a going concern. The financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.

We may need to engage in additional equity or debt financings to secure additional funds. We may not be able to obtain additional financing on terms favorable to us, or at all. To the extent that we raise additional capital through the future sales of equity or debt, the ownership interest of our stockholders will be diluted. The terms of these future or debt securities may include liquidation or other preferences that adversely affect the rights of our existing common stockholders or involve negative covenants that restrict our ability to take specific actions, such as incurring additional debt or making capital expenditures.
  
At June 30, 2020, we had cash and cash equivalents of $18.2 million and $0.5 million in restricted cash allocated to lease deposits. Based on our current operating plan, we expect to fund our operations, capital expenditure requirements and debt service with existing cash and cash equivalents as of June 30, 2020, anticipated revenue from operations, the successful completion of the milestones set forth in the Development Agreement and License Agreement, revenue that may be generated in connection with licensing its intellectual property, available sales of shares under the Sales Agreement and the Stock Purchase Agreement, and available borrowings under the revolving credit facility. We have based this expectation on assumptions that may prove to be wrong, such as the revenue that we expect to generate from the sale of our products, the gross profit we expect to generate from those revenues, any reduction in operating expenses in 2020, and the fact that we could use our capital resources sooner than we expect.

The COVID-19 pandemic has negatively impacted and will continue to impact our business, operations and financial condition. As part of our response to COVID-19, we took certain measures in preserving liquidity.  In addition to the furlough that we have implemented, we have eliminated, reduced, or are deferring significant non-essential expense including sales, marketing, quality, clinical, regulatory and all general and administrative expense. Non-essential programs have been eliminated or deferred where possible. In addition, we are working with suppliers to help match future revenue and expense.



43


Cash flows
 
The following table sets forth a summary of our cash flows for the periods indicated, as well as the year-over-year change (in thousands):
 
 
 
Six Months Ended June 30,
 
 
2020
 
2019
 
$ Change
 
% Change
Net cash (used in) provided by:
 
 

 
 

 
 

 
 

Operating activities
 
$
(12,337
)
 
$
(8,178
)
 
$
(4,159
)
 
(51
)%
Investing activities
 
(2,588
)
 
5,952

 
(8,540
)
 
(143
)
Financing activities
 
6,734

 
6,517

 
217

 
3

Effect of exchange rate on cash
 
(35
)
 
(12
)
 
(23
)
 
(192
)
Total
 
$
(8,226
)
 
$
4,279

 
$
(12,505
)
 
(292
)%
 
Net cash used in operating activities.    Net cash used in operating activities was $12.3 million for the six months ended June 30, 2020 and $8.2 million for the six months ended June 30, 2019, an increase of $4.2 million. These amounts primarily reflect net loss of $11.5 million for the six months ended June 30, 2020 and $14.3 million for the six months ended June 30, 2019. The net cash used in operating activities for the six months ended June 30, 2020 were affected by an increase in royalty and licensing receivable of $6.0 million, an increase in accounts payable, accrued expenses and other liabilities of $1.3 million, partially offset by decreases in prepaid expenses and other assets of $0.6 million and accounts receivable of $2.8 million. Non-cash reconciling items include a decrease from stock compensation expense of $0.5 million and a decrease from loss of extinguishment of debt of $1.1 million.
 
Net cash (used in) provided by investing activities.    Net cash used in investing activities was $2.6 million for the six months ended June 30, 2020, and for the six months ended June 30, 2019 net cash provided by investing activities was $6.0 million, a change of $8.5 million. These amounts primarily reflect a decrease in cash provided from matured investments of $7.3 million, and an increase in costs related to the acquisition of property, plant, and equipment of $1.3 million.
 
Net cash provided by financing activities.    Net cash provided by financing activities was $6.7 million for the six months ended June 30, 2020, and for the six months ended June 30, 2019 was $6.5 million, an increase of $0.2 million. The increase is due to $4.7 million of proceeds from the issuance of the PPP loan and net proceeds of $2.0 million from issuance of common stock compared to the net proceeds of $3.4 million from the refinancing of the Oxford debt and net proceeds of $3.1 million from issuance of common stock during the same period last year.
     
Contractual obligations and commitments
 
There have not been any material changes to our contractual obligations and commitments disclosed in the Management’s Discussion and Analysis of Financial Condition and Results of Operations in our Annual Report filed on Form 10-K for the year ended December 31, 2019 other than changes in our debt facilities as disclosed in "Note I—Debt and Notes Payable" in the financial statements and related notes appearing elsewhere in this Quarterly Report on Form 10-Q.

Revenue share agreements
 
We are party to revenue share agreements with certain past and present members of our scientific advisory board under which these advisors agreed to participate on our scientific advisory board and to assist with the development of our personalized implant products and related intellectual property. These agreements provide that we will pay the advisor a specified percentage of our net revenue, ranging from 0.1% to 1.33%, with respect to our products on which the advisor made a technical contribution or, in some cases, which we covered by a claim of one of or patents on which the advisor is a named inventor. The specific percentage is determined by reference to product classifications set forth in the agreement and is tiered based on the level of net revenue collected by us on such product sales. Our payment obligations under these agreements typically expire a fixed number of years after expiration or termination of the agreement, but in some cases expire on a product-by-product basis or expiration of the last to expire of our patents where the advisor is a named inventor that claims the applicable product.


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The aggregate revenue share percentage of net revenue from our currently marketed knee replacement products, including percentages under revenue share agreements with all of our scientific advisory board members, ranges, depending on the particular product, from 3.4% to 5.8%. We incurred aggregate revenue share expense including all amounts payable under our scientific advisory board revenue share agreements of $0.2 million during the three months ended June 30, 2020, representing 2.4% of product revenue, and $0.7 million during the three months ended June 30, 2019, representing 3.5% of product revenue. Revenue share expense is included in research and development. For further information, see “Note H—Commitments and Contingencies” to the consolidated financial statements appearing in this Quarterly Report on Form 10-Q.

Segment information
We have one primary business activity and operate as one reportable segment.

Off-balance sheet arrangements
 
Through June 30, 2020, we did not have any relationships with unconsolidated organizations or financial partnerships, such as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.
 
Critical accounting policies and significant judgments and use of estimates
 
We have prepared our consolidated financial statements in conformity with accounting principles generally accepted in the United States. Our preparation of these financial statements and related disclosures requires us 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 financial statements, and the reported amounts of revenue and expenses during the reporting periods. The accounting estimates that require our most significant estimates include revenue recognition, accounts receivable valuation, inventory valuations, purchase accounting, impairment assessments, equity instruments, stock compensation, income tax reserves and related allowances, the lives of property and equipment, and valuation of right-of-use lease assets and liabilities. We evaluate our estimates and judgments on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. Our critical accounting policies are more fully described under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Critical accounting policies and significant judgments and use of estimates” in our Annual Report on Form 10-K for the year ended December 31, 2019.

    

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ITEM 4. CONTROLS AND PROCEDURES
 
Evaluation of Disclosure Controls and Procedures
 
Our management, with the participation of our Chief Executive Officer and Chief Financial Officer (our principal executive officer and principal financial officer, respectively), evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2020. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2020, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting
 
No change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) occurred during the three months ended June 30, 2020 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the ordinary course of our business, we are subject to routine risk of litigation, claims and administrative proceedings on a variety of matters, including patent infringement, product liability, securities-related claims, and other claims in the United States and in other countries where we sell our products.

On August 15, 2019, we filed a lawsuit against Zimmer Biomet Holdings, Inc. and Zimmer, Inc., or “Zimmer Biomet,” in the United States District Court for the District of Delaware seeking damages for Zimmer Biomet’s infringement of certain of our patents related to patient-specific instrument and implant systems. The complaint alleges that Zimmer Biomet’s multiple lines of patient-specific instruments, as well as the implant components used in conjunction with them, infringe four of our patents. The accused product lines include Zimmer Biomet patient-specific instrument and implant systems for knee, shoulder, and hip replacement procedures.

On November 5, 2019, Zimmer Biomet filed a lawsuit against us in the United States District Court for the District of Delaware, alleging that we infringe five patents owned by Zimmer Biomet. Zimmer Biomet alleges that our iTotal CR and iTotal PS products infringe all five asserted patents, that our iDuo product infringes three of the asserted patents, and that our iUni product infringes two of the asserted patents. On January 13, 2020, Zimmer Biomet filed a motion to dismiss our complaint, and we filed our answer to Zimmer Biomet’s complaint, denying that our products infringe Zimmer Biomet’s asserted patents. Our answer also alleges that Zimmer Biomet’s asserted patents are invalid.

On May 22, 2020, we entered into a Settlement and License Agreement (the “Settlement and License Agreement”) with Zimmer Biomet, Zimmer US, Inc. and Biomet Manufacturing, LLC (collectively, “Zimmer Biomet”), pursuant to which the parties have agreed to terms for resolving their existing patent disputes. Under the Settlement and License Agreement, we agreed with Zimmer Biomet to dismiss both outstanding patent infringement lawsuits between the parties. Pursuant to the Settlement and License Agreement, we granted to Zimmer Biomet a royalty-free, non-exclusive, worldwide license to certain of our patents for Zimmer Biomet’s patient-specific instrumentation used with off-the-shelf knee, hip, and shoulder implants, and Zimmer Biomet granted to us a fully paid-up, royalty-free, non-exclusive, worldwide license to certain Zimmer Biomet patents for our implants and patient-specific instruments for the knee. Zimmer Biomet was required to pay us $3.5 million promptly after execution of the Settlement and License Agreement, which it has. Zimmer Biomet is also required to make additional payments to us on specified dates through January 15, 2021, for a total amount payable of $9.6 million, in consideration of the licenses, releases and other immunities granted by us to Zimmer Biomet. No payment is due from us to Zimmer Biomet.

On August 29, 2019, we filed a lawsuit against Medacta USA, Inc., or “Medacta,” in the United States District Court for the District of Delaware, and we amended our complaint on December 23, 2019, seeking damages for Medacta’s infringement of certain of our patents related to patient-specific instrument and implant systems. We allege in the lawsuit that Medacta’s multiple lines of patient-specific instruments, as well as the implant components used in conjunction with them, infringe four of our patents. The accused product lines include Medacta patient-specific instrument and implant systems for knee and shoulder replacement procedures. On January 6, 2020, Medacta filed its answer, denying that its patient-specific instrument and implant systems infringe the patents asserted by us. Medacta’s answer also alleges the affirmative defense that our asserted patents are invalid. Discovery is proceeding in the lawsuit.

On March 20, 2020, Osteoplastics LLC, or "Osteoplastics" filed a lawsuit against us in the United States District Court for the District of Delaware, and Osteoplastics amended its complaint on April 2, 2020, alleging that we infringe seven patents owned by Osteoplastics. Osteoplastics alleges that our proprietary software, including our iFit software platform, and our use of our proprietary software for designing and manufacturing medical devices, including implants, infringes the seven asserted patents. On June 15, 2020, we filed a motion to dismiss Osteoplastics’ complaint. The court has not yet ruled on the motion to dismiss.

On April 24, 2020, we filed a lawsuit against Wright Medical Technology, Inc. and Tornier, Inc., or “Wright Medical,” in the United States District Court for the District of Delaware seeking damages for Wright Medical’s infringement of certain of our patents related to patient-specific instrument and implant systems. The complaint alleges that Wright Medical’s multiple lines of patient-specific shoulder instruments, as well as the implant

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components used in conjunction with them, infringe four of our patents. The accused product lines include Wright Medical’s Tornier Blueprint™ 3D Planning + PSI shoulder replacement systems.

On May 8, 2020, we and an individual plaintiff filed a lawsuit against Aetna, Inc. and Aetna Life Insurance Company or “Aetna” in the United States District Court for the District of Massachusetts seeking damages for Aetna’s improper denial of coverage for personalized knee implants under its health plans and the ones it administers. The complaint alleges that Aetna has violated its duties under state and federal law, including the Employee Retirement Income Security Act. On July 23, 2020, Aetna filed a motion to dismiss the complaint.  The court has not yet ruled on the motion to dismiss.

Adverse outcomes of these lawsuits could have a material adverse effect on our business, financial condition or results of operations. We are presently unable to predict the outcome of these lawsuits or to reasonably estimate a range of potential losses, if any, related to the lawsuits.

    



ITEM 1A. RISK FACTORS
We operate in a rapidly changing environment that involves a number of risks that may have a material adverse effect on our business, financial condition and results of operations. The following description of risk factors consists of updates to the risk factors previously disclosed in Part 1, Item 1A in our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 (the “Form 10-K”). For a detailed discussion of the other risks that affect our business, please refer to the entire section entitled “Risk Factors” in our Form 10-K. Other than as set forth below, there have been no material changes to our risk factors as previously disclosed in our Form 10-K. Risk factors and other information included in our Form 10-Q should be carefully considered. Additional risks and uncertainties not presently known to us or that we presently deem less significant may also impair our business operations. Please see page 28 of this Quarterly Report on Form 10-Q for a discussion of some of the forward-looking statements that are qualified by these risk factors. If any of the risks actually occur, our business, financial condition, results of operations and future growth prospects could be materially and adversely affected.

The novel coronavirus (COVID-19) pandemic and the response to it have reduced demand for our products, and as a result we reduced our operations and production capacity, and these circumstances have had and may continue to have a material adverse effect on our business, operations and financial condition.
In December 2019, an outbreak of respiratory illness caused by a novel coronavirus began in Wuhan, China. As of August [3], 2020, that outbreak has led to more than [16.3] million confirmed cases worldwide, with many countries throughout the world confirming cases. The World Health Organization has declared the outbreak a pandemic and a global public health emergency. In addition to those who have been directly affected, millions more have been affected by government efforts in the United States, the European Union and around the world to slow the spread of the pandemic through quarantines, travel restrictions, heightened border scrutiny and other measures. The pandemic and measures taken in response by governments, private industry, individuals and others have also had significant direct and indirect adverse impacts on businesses and commerce as supply chains have been disrupted; facilities and production have been suspended; and demand for certain goods and services has spiked, while demand for other goods and services has decreased significantly.
The future progression of the pandemic and its effects on our business and operations are highly uncertain. We have experienced significantly decreased demand for our products and expect further unpredictable and potentially significant reductions in demand for our products as healthcare providers and individuals continue to de-prioritize and defer medical procedures that are deemed to be elective, such as joint replacement procedures, which has had and may continue to have a material adverse effect on our business, operations and financial condition.
On March 20, 2020, we provided notice to our employees of a furlough of approximately 80 employees effective as of March 23, 2020 to help address decreased demand for our products. The furlough resulted in limited production capacity at our manufacturing facilities, but sufficient to meet demand. While we have not experienced significant interruptions in our supply chain, extended or additional quarantines, travel restrictions and other measures may significantly impact the ability of employees of our third-party suppliers to get to their places of work

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to manufacture the key components and materials necessary for our products. We have experienced and may experience further shortages of mask and gown consumables used in our clean room processes, which may further limit our production capacity and further delay the joint replacement procedures in which our products are used. Any delay or shortage of such components or materials or delays in delivering our products may result in our inability to satisfy consumer demand for our products in a timely manner or at all, which could harm our reputation, future sales, profitability and financial condition. On April 23, 2020, we accelerated a plan to return to full-time employment the vast majority of those employees who were furloughed on March 23, 2020.
The coronavirus pandemic continues to rapidly evolve. There may be other material adverse impacts on our business, operations and financial condition that are unpredictable at this time, including delays in the development and regulatory approval of new products and difficulties in retaining qualified personnel, sales representatives and distributors during the pandemic. The extent to which the pandemic may impact our business will depend on future developments, such as the duration of the pandemic, quarantines, travel restrictions and other measures in the United States, the European Union and around the world, business closures or business disruptions and the effectiveness of actions taken to contain the pandemic.

The new covenants set forth in the Third Amendment to the 2019 Secured Loan Agreement with Innovatus may be difficult for us to satisfy, and failure to do so would constitute an event of default and permit Innovatus to exercise remedies against us and our assets, including charging additional interest, taking control of our cash and commencing foreclosure proceedings on our other assets.
On July 1, 2020, we entered into a Third Amendment ("Amendment") to the 2019 Secured Loan Agreement with Innovatus, as collateral agent and lender, East West Bank and the Lenders, dated as of June 25, 2019 ("Loan Agreement"). The Amendment, among other things, waives the trailing six-month revenue covenant milestones that apply to the quarters ending June 30, September 30 and December 31, 2020 under the Loan Agreement and reduces the revenue covenant milestones that apply thereafter, delays until June 25, 2021 our option to prepay all, but not less than all, of the term loans advanced under the Loan Agreement and includes a new covenant that we raise additional capital. The Amendment also increases our minimum cash covenant to $5.0 million until December 31, 2020, provided that such cash covenant shall be further increased to $10.0 million, commencing on January 1, 2021, if we have not yet satisfied the new covenant relating to raising capital. The capital raise covenant in the Amendment specifies that on or before December 31, 2020, we shall receive aggregate gross cash proceeds of not less than $20.0 million from (i) the sale and issuance of our equity securities (including, without limitation, by means of at-the-market (ATM) offering, private placements, follow on public offerings), (ii) net payments received from any of patent infringement disputes with Zimmer Biomet on or after July 1, 2020 and on or before December 31, 2020, (iii) net payments received from any of our other patent infringement disputes with any other party not specified in clause (ii), (iv) monetization of R&D tax credits or NOLs as part of any current or future 2020 government stimulus packages, or (v) governmental grants that are not (in whole or in part) in the form of indebtedness, or any combination of two or more of the foregoing. If the capital raise event has not occurred by December 31, 2020 and if we are in compliance with our revenue covenant milestones as of January 1, 2021, the period to comply with capital raise covenant will automatically extend to June 30, 2021. During the capital raise event extension period (i) commencing on January 1, 2021 and ending on (and including) March 31, 2021, we shall not have any indebtedness outstanding under the revolving line in excess of $2.5 million and (ii) commencing on April 1, 2021 and ending on (and including) June 30, 2021, we shall not have any indebtedness outstanding under the revolving line in excess of $5.0 million.
We may be unable to comply with the capital raise event covenant, the increased minimum cash covenant or other new or updated covenants contained in our Loan Agreement with Innovatus, which would be an event of default under the Loan Agreement. This risk may be exacerbated by the coronavirus pandemic and other adverse changes in general economic, industry and market conditions. Upon an event of default, Innovatus would be permitted to exercise remedies against us and our assets, including charging interest at the rate that is otherwise applicable plus 5.0%, taking control of our cash and commencing foreclosure proceedings on our other assets. For more information regarding the risks related to our Loan Agreement, see “Risk Factors--Risks related to our financial position--Our existing and any future indebtedness could adversely affect our ability to operate our business” in our Annual Report on Form 10-K.




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ITEM 2. UNREGISTERED SALES OF SECURITIES AND USE OF PROCEEDS
Unregistered Sales of Securities

We did not sell any shares of our common stock, shares of our preferred stock or warrants to purchase shares of our stock, or grant any stock options or restricted stock awards, during the period covered by this Quarterly Report on Form 10-Q that were not registered under the Securities Act of 1933, as amended, or the Securities Act, and that have not otherwise been described in a Current Report on Form 8-K.



ITEM 5. OTHER INFORMATION


On [August 5, 2020], we filed with the SEC a prospectus supplement, for the sale and issuance of up to $25 million of its common stock and entered into an at-the-market issuance sales agreement, or the Sales Agreement, with Cowen and Company, LLC, or Cowen, pursuant to which we may offer and sell shares of the our common stock to or through Cowen, acting as agent and/or principal, from time to time in an “at-the-market” offering as defined in Rule 415 promulgated under the Securities Act of 1933, as amended, including without limitation sales made by means of ordinary brokers’ transactions on the Nasdaq Global Select Market or otherwise at market prices prevailing at the time of sale, in block transactions, or as otherwise directed by us. Cowen will use commercially reasonable efforts to sell the Common Stock from time to time, based upon instructions from us (including any price, time or size limits or other customary parameters or conditions we may impose). We will pay Cowen a commission of up to 3.0% of the gross sales proceeds of any Common Stock sold through Cowen under the Sales Agreement, and also has provided Cowen with customary indemnification rights.

The shares of Common Stock being offered pursuant to the Sales Agreement will be offered and sold pursuant to the New Shelf Registration Statement. We are not obligated to make any sales of Common Stock under the Sales Agreement. The offering of shares of Common Stock pursuant to the Sales Agreement will terminate upon the earlier of (i) the sale of all Common Stock subject to the Sales Agreement or (ii) termination of the Sales Agreement in accordance with its terms.

The foregoing description of the Sales Agreement is not complete and is qualified in its entirety by reference to the full text of the Sales Agreement, a copy of which is filed herewith as Exhibit 10.1 and is incorporated herein by reference.

The shares of Common Stock being offered pursuant to the Sales Agreement will be offered and sold pursuant to our shelf registration statement on Form S-3 (File No. 333-237351). On August [5], 2020, we filed a prospectus supplement relating to the ATM Offering with the Securities and Exchange Commission (the “SEC”).

The legal opinion of Wilmer Cutler Pickering Hale and Dorr LLP relating to the shares of Common Stock being offered pursuant to the Sales Agreement is filed as Exhibit 5.1.







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ITEM 6. EXHIBITS

The exhibits filed as part of this Quarterly Report on Form 10-Q are set forth on the Exhibit Index, which Exhibit Index is incorporated herein by reference.

EXHIBIT INDEX
Exhibit
Number
 
Description of Exhibit
 
 
 
 
 
 
 
 
101.INS
 
XBRL Instance Document
101.SCH
 
XBRL Taxonomy Extension Schema Document
101.CAL
 
XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB
 
XBRL Taxonomy Extension Label Linkbase Database
101.PRE
 
XBRL Taxonomy Extension Presentation Linkbase Document
101.DEF
 
XBRL Taxonomy Extension Definition Linkbase Document
*
Filed herewith.
#
This certification will not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), or otherwise subject to the liability of that section. Such certification will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933, as amended, or the Exchange Act, except to the extent specifically incorporated by reference into such filing.
 
 

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SIGNATURES
 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 Date: 8/5/2020

 
 
CONFORMIS, INC.
 
 
 
 
 
By:
 
/s/ Mark A. Augusti
 
 
 
 
Mark A. Augusti
President and Chief Executive Officer

 Date: 8/5/2020
 
 
CONFORMIS, INC.
 
 
 
 
 
By:
 
/s/ Robert Howe
 
 
 
 
Robert Howe
Chief Financial Officer (Principal Financial Officer)


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