Edgar Filing: ConforMIS Inc

Document

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2016

¨ 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)



28 Crosby Drive Bedford, MA	01730
(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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.



Large accelerated filer	o	Accelerated filer	o

Non-accelerated filer	x (Do not check if a smaller reporting company)	Smaller reporting company	o

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

As of October 31, 2016, there were 42,883,156 shares of Common Stock, $0.00001 par value per share, outstanding.

ConforMIS, Inc.

INDEX



	Page

Part I - FINANCIAL INFORMATION
Item 1. Financial Statements (interim periods unaudited)	1
Consolidated Balance Sheets as of September 30, 2016 and December 31, 2015	1
Consolidated Statements of Operations for the three and nine months ended September 30, 2016 and 2015	2
Consolidated Statement of Comprehensive Loss for the three and nine months ended September 30, 2016 and 2015	3
Consolidated Statements of Cash Flows for the nine months ended September 30, 2016 and 2015	4
Notes to Consolidated Financial Statements	5
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3. Quantitative and Qualitative Disclosures About Market Risk	33
Item 4. Controls and Procedures	33

Part II- OTHER INFORMATION
Item 1. Legal Proceedings	35
Item 1A. Risk Factors	36
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds	75
Item 6. Exhibits	76
Signatures	77

PART I - FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

CONFORMIS, INC. AND SUBSIDIARIES

Consolidated Balance Sheets

(in thousands, except share and per share data)



	September 30, 2016			December 31, 2015
	(unaudited)
Assets
Current Assets
Cash and cash equivalents	$	34,986		$	117,185
Investments	38,337			—
Accounts receivable, net	13,839			14,867
Inventories	11,755			11,520
Prepaid expenses and other current assets	2,242			2,451
Total current assets	101,159			146,023
Property and equipment, net	14,985			10,966
Other Assets
Restricted cash	300			600
Investments	2,497			—
Intangible assets, net	808			995
Goodwill	753			753
Other long-term assets	29			32
Total assets	$	120,531		$	159,369

Liabilities and stockholders' equity
Current liabilities
Accounts payable	$	4,392		$	4,718
Accrued expenses	6,246			7,811
Deferred revenue	305			305
Current portion of long-term debt	257			295
Total current liabilities	11,200			13,129
Other long-term liabilities	166			220
Deferred revenue	4,396			4,625
Long-term debt	—			183
Total liabilities	15,762			18,157
Commitments and contingencies	—			—
Stockholders’ equity
Preferred stock, $0.00001 par value:
Authorized: 5,000,000 shares authorized as of September 30, 2016 and December 31, 2015; no shares issued and outstanding as of September 30, 2016 and December 31, 2015	—			—
Common stock, $0.00001 par value:
Authorized: 200,000,000 shares authorized as of September 30, 2016 and December 31, 2015; 42,758,693 and 41,110,127 shares issued and outstanding as of September 30, 2016 and December 31, 2015, respectively	—			—
Additional paid-in capital	472,778			467,075
Accumulated deficit	(367,190		)	(325,342		)
Accumulated other comprehensive loss	(819		)	(521		)
Total stockholders’ equity	104,769			141,212
Total liabilities and stockholders’ equity	$	120,531		$	159,369

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

CONFORMIS, INC. AND SUBSIDIARIES

Consolidated Statements of Operations

(unaudited)

(in thousands, except share and per share data)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Revenue
Product	$	18,400		$	13,490		$	57,486		$	43,953
Royalty	243			404			740			3,863
Total revenue	18,643			13,894			58,226			47,816
Cost of revenue	12,645			11,132			39,564			32,371
Gross profit	5,998			2,762			18,662			15,445

Operating expenses
Sales and marketing	9,301			9,433			31,063			27,584
Research and development	4,099			3,885			12,474			12,218
General and administrative	5,503			5,656			17,285			16,790
Total operating expenses	18,903			18,974			60,822			56,592
Loss from operations	(12,905		)	(16,212		)	(42,160		)	(41,147		)

Other income and expenses
Interest income	127			24			409			92
Interest expense	(4		)	(911		)	(104		)	(1,380		)
Other income (expense)	34			—			34			208
Total other income/(expenses), net	157			(887		)	339			(1,080		)
Loss before income taxes	(12,748		)	(17,099		)	(41,821		)	(42,227		)
Income tax provision	14			8			27			29

Net loss	$	(12,762	)	$	(17,107	)	$	(41,848	)	$	(42,256	)

Net loss per share - basic and diluted	$	(0.31	)	$	(0.45	)	$	(1.01	)	$	(2.69	)

Weighted average common shares outstanding - basic and diluted	41,682,244			37,933,069			41,332,958			15,688,686

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

CONFORMIS, INC. AND SUBSIDIARIES

Consolidated Statements of Comprehensive Loss

(unaudited)

(in thousands)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2016			2015			2016			2015
Net loss	$	(12,762	)	$	(17,107	)	$	(41,848	)	$	(42,256	)
Other comprehensive income (loss)
Foreign currency translation adjustments	(167		)	(60		)	(300		)	154
Change in unrealized gain (loss) on available-for-sale securities, net of tax	(8		)	—			2			—
Comprehensive loss	$	(12,937	)	$	(17,167	)	$	(42,146	)	$	(42,102	)

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

CONFORMIS, INC. AND SUBSIDIARIES

Consolidated Statements of Cash Flows

(unaudited)

(in thousands)



	Nine Months Ended September 30,
	2016			2015
Cash flows from operating activities
Net loss	$	(41,848	)	$	(42,256	)

Adjustments to reconcile net loss to net cash used by operating activities:
Depreciation and amortization expense	2,334			1,891
Amortization of debt discount	3			135
Stock-based compensation expense	3,490			2,594
Provision for bad debts on trade receivables	243			171
Impairment of long-term assets	123			—
Disposal of long term-assets	—			2
Amortization/accretion on investments	229			—
Tax effect, unrealized gain/loss on investments	(1		)	—
Changes in operating assets and liabilities:
Accounts receivable	785			687
Inventories	(235		)	(2,974		)
Prepaid expenses and other assets	212			(969		)
Accounts payable and accrued liabilities	(1,892		)	2,242
Deferred royalty revenue	(229		)	5,009
Other long-term liabilities	(54		)	(31		)
Net cash used in operating activities	(36,840		)	(33,499		)

Cash flows from investing activities:
Acquisition of property and equipment	(6,289		)	(3,666		)
Decrease (increase) in restricted cash	300			3,717
Purchase of investments	(57,559		)	—
Maturity of investments	16,500			—
Net cash used in investing activities	(47,048		)	51

Cash flows from financing activities:
Proceeds from exercise of common stock options	2,213			561
Proceeds from exercise of common stock warrant	—			18
Proceeds from exercise of preferred stock warrant	—			4,458
Payments on long-term debt	(224		)	(10,207		)
Net proceeds from issuance of common stock	—			139,766
Net cash provided by financing activities	1,989			134,596
Foreign exchange effect on cash and cash equivalents	(300		)	154
(Decrease) increase in cash and cash equivalents	(82,199		)	101,302
Cash and cash equivalents, beginning of period	117,185			37,900
Cash and cash equivalents, end of period	$	34,986		$	139,202

Non cash investing and financing activities
Accrued financing costs	—			407

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

CONFORMIS, INC. AND SUBSIDIARIES

Notes to Consolidated Financial Statements

(unaudited)

Note A—Organization and Basis of Presentation

ConforMIS, Inc. and its subsidiaries (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 customized, to fit each patient’s unique anatomy. The Company’s proprietary iFit® technology platform is potentially applicable to all major joints. The Company offers a broad line of customized knee implants designed to restore the natural shape of a patient’s knee.

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 and its iTotal PS in 2015. The Company has its corporate offices in Bedford, Massachusetts.

Liquidity and operations

Since the Company’s inception in June 2004, it has financed its operations through private placements of preferred stock, its initial public offering (the "IPO") in July 2015, bank debt and convertible debt financings, equipment purchase loans, and, beginning in 2007, product revenue. To date, the Company’s product revenue has continued to grow from year-to-year; however, it has not yet attained profitability and continues to incur operating losses. At September 30, 2016, the Company had an accumulated deficit of $367.2 million

The Company’s principal sources of funds are revenue generated from the sale of its products and the net proceeds from the IPO.

As of September 30, 2016, the Company had cash and cash equivalents, and short-term and long-term investments of $75.8 million and $0.3 million in restricted cash allocated to lease deposits. As of December 31, 2015, the Company had cash and cash equivalents of $117.2 million and $0.6 million in restricted cash allocated to lease deposits.

As of September 30, 2016, based on its current operating plan, the Company expects that its existing cash and cash equivalents as of September 30, 2016 and anticipated revenue from operations, including from projected sales of its products, will enable it to fund operating expenses and capital expenditure requirements and pay its debt service as it becomes due for at least the next 12 months.

In the event the Company’s existing cash and available financing are not sufficient to fund its operations, the Company may need to engage in equity or debt financings to secure additional funds. 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 the valuation of accounts receivable, inventory reserves, intangible valuation, equity instruments, impairment assessments, income tax reserves and related allowances, and the lives of property and equipment. 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, 2015.

Unaudited Interim Financial Information

The accompanying Interim Consolidated Financial Statements as of September 30, 2016 and for the three and nine months ended September 30, 2016 and 2015, 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, or 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 September 30, 2016, results of operations for the three and nine months ended September 30, 2016 and 2015, and cash flows for the nine months ended September 30, 2016 and 2015. The results for the three and nine months ended September 30, 2016 are not necessarily indicative of the results expected for the full year or any interim period.

Note B—Summary of Significant Accounting Policies

Concentrations of credit risk and other risks and uncertainties

Financial instruments that subject the Company to credit risk primarily consist of cash, cash equivalents, investments, and accounts receivable. The Company maintains the majority of its cash and investments with accredited financial institutions.

The Company and its contract manufacturers rely on sole source suppliers 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. The Company is in the process of validating alternate suppliers relative to certain key components, which are expected to be phased in during the coming periods.

For the three and nine months ended September 30, 2016 and 2015, no customer represented greater than 10% of revenue. There were no customers that represented greater than 10% of total gross receivable balance as of September 30, 2016 or December 31, 2015.

Principles of consolidation

The consolidated financial statements include the accounts of the Company and its wholly owned subsidiaries including ImaTx, Inc. ("ImaTx"), ConforMIS Europe GmbH, ConforMIS UK Limited and ConforMIS Hong Kong Limited. All material intercompany balances and transactions have been eliminated in consolidation.

Cash and cash equivalents

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 and money market accounts on deposit with certain financial institutions. Demand deposits are carried at cost which approximates their fair value. Money market accounts are carried at fair value based upon level 1 inputs. The associated risk of concentration is mitigated by banking with credit worthy financial institutions.

The Company had $2.5 million as of September 30, 2016 and $2.1 million as of December 31, 2015 held in foreign bank accounts. In addition, the Company has recorded restricted cash of $0.3 million as of September 30, 2016 and $0.6 million as of December 31, 2015. Restricted cash consisted of security provided for lease obligations.

Investment securities

The Company classifies its investment securities as available-for-sale. Those investments with maturities less than 12 months at the date of purchase are considered short-term investments. Those investments with maturities greater than 12 months at the date of purchase are considered long-term investments. The Company’s investment securities classified as available-for-sale are recorded at fair value based upon quoted market prices at period end. Unrealized gains and losses, deemed temporary in nature, are reported as a separate component of accumulated other comprehensive income (loss).

A decline in the fair value of any security below cost that is deemed other than temporary results in a charge to earnings and the corresponding establishment of a new cost basis for the security. Premiums (discounts) are amortized (accreted) over the life of the related security the constant yield method. Dividend and interest income are recognized when earned and reported in other income. Realized gains and losses are included in earnings and are derived using the specific identification method for determining the cost of securities sold.

Fair value of financial instruments

Certain of the Company’s financial instruments, including cash and cash equivalents but 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. Financial instruments including money market funds and investments are carried at fair value.

Accounts receivable and allowance for doubtful accounts

Accounts receivable consist of amounts due from 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 at the time potential 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 market 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, with market determined based on net realizable value. Appropriate consideration is given to inventory items sold at negative gross margins, purchase commitments and other factors in evaluating net realizable value.

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.

Intangibles and other long-lived assets

Intangible assets consist of developed technology and other intellectual property rights licensed from ImaTx. Intangible assets are carried at cost less accumulated amortization.

The Company tests impairment of long-lived assets when events or changes in circumstances indicate that the assets might be impaired. For assets with determinable useful lives, amortization is computed using the straight-line method over the estimated economic lives of the respective intangible assets.

Furthermore, periodically the Company assesses whether long-lived assets, including intangible assets, should be tested for recoverability whenever events or circumstances indicate that their carrying value may not be recoverable.

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. 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 nine months ended September 30, 2016, the Company recognized an impairment of long-term assets of $0.1 million in connection with certain manufacturing equipment previously

purchased that will be returned to the seller in exchange for credit toward a future purchase, which value is less than the book value of the equipment. During the nine months ended September 30, 2015, no such impairment charges were recognized.

Goodwill

Goodwill relates to amounts that arose in connection with the acquisition of Imaging Therapeutics, Inc. (formerly known as Osteonet.com, renamed ImaTx, Inc.) in 2009. The Company tests goodwill at least annually for impairment, or more frequently when events or changes in circumstances indicate that the assets may be impaired. This impairment test is performed annually during the fourth quarter at the reporting unit level. Goodwill may be considered impaired if the carrying value of the reporting unit, including goodwill, exceeds the reporting unit’s fair value. The Company is comprised of one reporting unit. When testing goodwill for impairment, the Company primarily looks to the fair value of the reporting unit, which is typically estimated using a discounted cash flow approach, which requires the use of assumptions and judgments including estimates of future cash flows and the selection of discount rates. During the nine months ended September 30, 2016, and 2015, there were no triggering events which would require an interim goodwill impairment assessment.

Revenue recognition

Product

The Company generates revenue from the sale of customized implants and instruments to medical facilities through the use of a combination of direct sales personnel, independent sales representatives and distributors in the United States, Germany, the United Kingdom, Ireland, Austria, Switzerland, Singapore and Hong Kong.

Revenue is recognized when all of the following criteria are met:


•	persuasive evidence of an arrangement exists;


•	the sales price is fixed or determinable;


•	collection of the relevant receivable is probable at the time of sale; and


•	delivery has occurred or services have been rendered.

For a majority of sales to medical facilities, the Company recognizes revenue upon completion of the procedure, which represents satisfaction of the required revenue recognition criteria. For the remaining sales, which are made directly through distributors and generally represent less than 1% of revenue, the Company recognizes revenue at the time of shipment of the product, which represents the point in time when the customer has taken ownership and assumed the risk of loss and the required revenue recognition criteria are satisfied. Such customers are obligated to pay within specified time periods regardless of when or if they ever sell or use the products. Once the revenue recognition criteria have been satisfied the Company does not offer rights of return or price protection and there are no post-delivery obligations.

Royalty

The Company has accounted for royalty agreements with Wright Medical Group, Inc. and MicroPort Orthopedics, Inc. under Accounting Standards Codification ("ASC") 605-25, Multiple-Element Arrangements and Staff Accounting Bulletin No. 104, Revenue Recognition (ASC 605). In accordance with ASC 605, the Company is required to identify and account for each of the separate units of accounting. The Company identified the relative selling price for each and then allocated the total consideration based on their relative values. In connection with these agreements, in April 2015, the Company recognized in aggregate (i) back-owed royalties of $3.4 million as royalty revenue and (ii) the value attributable to the settlements of $0.2 million as other income. Additionally, the Company recognized an initial $5.1 million in aggregate as deferred royalty revenue, which is recognized as royalty revenue ratably through 2031. The on-going royalty from MicroPort is recognized as royalty revenue upon receipt of payment.

Shipping and handling costs

Amounts invoiced to customers for shipping and handling are classified as revenue. Shipping and handling costs incurred are included in general and administrative expense.

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, 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, which are included in sales and marketing, are expensed as incurred. Advertising expense was $19,000 and $41,000 for the three months ended September 30, 2016 and 2015, respectively, and was $202,000 and $192,000 for the nine months ended September 30, 2016 and 2015, 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 customized joint replacement products and that the Company operates as one segment. See “Note J—Segment and Geographic Data”.

Comprehensive loss

As of September 30, 2016 and 2015, accumulated other comprehensive loss consists of foreign currency translation adjustments and changes in unrealized gain and loss of available-for-sale securities, net of tax.

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 as of the balance sheet date, and income and expense items are translated at average rates of exchange prevailing during the period. Gains and losses realized from transactions denominated in foreign currencies, including intercompany balances not considered permanent investments, 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. Valuation allowance is maintained to reduce deferred tax assets to the amount expected to be realized.

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 is subject to U.S. federal, state, and foreign income taxes. The Company recorded a provision for income taxes of approximately $14,000 and $8,000 for the three months ended September 30, 2016 and 2015, respectively, and $27,000 and $29,000 for the nine months ended September 30, 2016 and 2015, respectively.

The Company recognizes interest and penalties related to income taxes as a component of income tax expense. As of September 30, 2016 and December 31, 2015, $11,000 and $6,000 of interest and penalties have been accrued, respectively.

Medical device excise tax

The Company is subject to the Health Care and Education Reconciliation Act of 2010 (the “Act”), which imposes a tax equal to 2.3% on the sales price of any taxable medical device by a medical device manufacturer, producer or importer of such device. Under the Act, a taxable medical device is any device defined in Section 201(h) of the Federal Food, Drug, and Cosmetic Act ("FDA"), intended for humans, which includes an instrument, apparatus, implement, machine, contrivance, implant, in vitro reagent, or other similar or related article, including any component, part, or accessory, which meets certain requirements. The Consolidated Appropriations Act of 2016 includes a two-year moratorium on the medical device excise tax, which moratorium suspended taxes on the sale of a taxable medical device by the manufacturer, producer, or importer of the device during the period beginning on January 1, 2016 and ending on December 31, 2017. The Company incurred medical device excise tax expense of $0 million and $0.2 million for the three months ended September 30, 2016 and 2015, respectively, and $0 million and $0.6 million for the nine months ended September 30, 2016 and 2015, respectively. Medical device tax is included in general and administrative expense.

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. The exercise prices for option grants are set by the Company’s board of directors and, prior to the Company’s IPO in July 2015, were based upon guidance set forth by the American Institute of Certified Public Accountants, or AICPA, in its Technical Practice Aid, “Valuation of Privately Held Company Equity Securities Issued as Compensation”. To that end, the board considered a number of factors in determining the option price, including: (1) past sales of the Company’s convertible preferred stock, and the rights, preferences and privileges of the Company stock, (2) obtaining FDA 510(k) clearance, and (3) achievement of budgeted results. See “Note I—Stockholders’ Equity” for a summary of the stock option activity under the Company’s stock-based compensation plan.

Net loss per share

The Company calculates net 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.

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 September 30,						Nine Months Ended September 30,
(in thousands, except share and per share data)	2016			2015			2016			2015
Numerator:
Numerator for basic and diluted loss per share:
Net loss	$	(12,762	)	$	(17,107	)	$	(41,848	)	$	(42,256	)
Denominator:
Denominator for basic loss per share:
Weighted average shares	41,682,244			37,933,069			41,332,958			15,688,686
Basic loss per share attributable to ConforMIS, Inc. stockholders	$	(0.31	)	$	(0.45	)	$	(1.01	)	$	(2.69	)
Diluted loss per share attributable to ConforMIS, Inc. stockholders	$	(0.31	)	$	(0.45	)	$	(1.01	)	$	(2.69	)

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 September 30,		Nine Months Ended September 30,
	2016	2015	2016	2015
Series A Preferred	—	129,739	—	1,172,282
Series B Preferred	—	170,029	—	1,536,334
Series C Preferred	—	186,643	—	1,686,450
Series D Preferred	—	508,895	—	4,576,684
Series E-1 Preferred	—	556,709	—	5,030,261
Series E-2 Preferred	—	390,295	—	3,526,593
Series C Preferred Warrants	—	—	—	—
Series D Preferred Warrants	—	—	—	—
Common stock warrants	18,443	—	42,169	329,348
Stock options and restricted stock awards	1,583,269	3,887,561	2,068,315	3,880,463
Total	1,601,712	5,829,871	2,110,484	21,738,415

Recent accounting pronouncements

In June 2016, the Financial Accounting Standards Board ("FASB") issued ASU No. 2016-12, "Revenue from Contracts with Customers (Topic 606): Narrow-Scope Improvements and Practical Expedients" ("ASU 2016-12") which provides guidance for accounting of credit losses affecting the impairment model for most financial assets and certain other instruments. Entities will be required to use a new forward-looking current expected credit loss model for trade and other receivables, held-to-maturity debt securities, loans and other instruments, which will generally lead to an earlier recognition of loss allowances. Entities will recognize losses on available-for-sale debt securities as allowances rather than a reduction in amortized cost of the security while the measurement process of this loss does not change. Disclosure requirements are expanded regarding an entity’s assumptions, models and methods of estimations of the allowance. The guidance will be effective in the first quarter of 2020, with the option for early adoption. The Company is currently evaluating the impact of this pronouncement on its consolidated financial statements and expects to adopt this pronouncement commencing in the first quarter of 2020.

In April 2016, the FASB issued ASU 2016-10, "Identifying Performance Obligations and Licensing" ("ASU 2016-10"). This ASU clarifies two aspects of ASU 2014-09, "Revenue from Contracts with Customers (Topic 606): identifying performance obligations and the licensing implementation guidance". ASU 2016-10 will become effective for the first quarter of 2018. The Company is currently evaluating the impact of this pronouncement on its consolidated financial statements and expects to adopt this pronouncement commencing in the first quarter of 2018.

In March 2016, the FASB issued ASU No. 2016-08, "Revenue from Contracts with Customers (Topic 606): Principal versus Agent Considerations (Reporting Revenue Gross versus Net)" ("ASU 2016-08") which clarifies the implementation guidance on principal versus agent considerations. The guidance includes indicators to assist an entity in determining whether it controls a specified good or service before it is transferred to the customers. This guidance will be effective in the first quarter of 2018, with the option to adopt it in the first quarter of 2017. The Company is currently evaluating the impact of this pronouncement on its consolidated financial statements and expects to adopt this pronouncement commencing in the first quarter of 2018.

In March 2016, the FASB issued ASU No. 2016-09, "Compensation—Stock Compensation (Topic 718)" ("ASU 2016-09"). This standard makes several modifications to Topic 718 related to the accounting for forfeitures, employer tax withholding on share-based compensation and the financial statement presentation of excess tax benefits or deficiencies. ASU 2016-09 also clarifies the statement of cash flows presentation for certain components of share-based awards. The standard is effective for interim and annual reporting periods beginning after December 15, 2016, although early adoption is permitted. The Company is currently evaluating the impact of this pronouncement on its consolidated financial statements and expects to adopt this pronouncement commencing in the first quarter of 2017.

Reclassification

During the quarter ended June 30, 2016, the Company identified that certain costs of revenue had been improperly classified as sales and marketing expense in the Consolidated Statements of Operations. The Company has concluded that the prior classification was an error and that it is immaterial to all annual and quarterly periods previously presented. However, to facilitate period-over-period comparisons, the Company has revised its prior period financial statements to reflect the corrections in the period in which the expenses were incurred. As a result, the Company reclassified $0.8 million and $2.0 million from sales and marketing to cost of revenue for the three and nine months ended September 30, 2015, respectively. In addition, the Company reclassified $0.4 million for the three months ended March 31, 2016 from sales and marketing to cost of revenue. These reclassifications did not have any impact on loss from operations, net loss per share - basic and diluted or accumulated deficit. For year-over-year comparison, the Company incurred related expense, included in cost of revenue, of $1.3 million and $2.8 million for the three and nine months ended September 30, 2016, respectively.

Note C—Fair Value Measurements

The Fair Value Measurements topic of the FASB Codification establishes a framework for measuring fair value in accordance with U.S. GAAP, clarifies the definition of fair value within that framework and expands disclosures about fair value measurements. This guidance requires disclosure regarding the manner in which fair value is determined for assets and liabilities and establishes a three-tiered value hierarchy into which these assets and liabilities must be grouped, based upon significant levels of inputs as follows:

Level 1—Quoted prices in active markets for identical assets or liabilities.

Level 2—Observable inputs, other than Level 1 prices, such as quoted prices in active markets for similar assets and liabilities, quoted prices for identical or similar assets and liabilities in markets that are not active, or other inputs that are observable or can be corroborated by observable market data.

Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

The Company's investment policy is consistent with the definition of available-for-sale securities. All investments have been classified within Level 1 or Level 2 of the fair value hierarchy because of the sufficient observable inputs for revaluation. The Company's Level 1 cash equivalents and investments are valued using

quoted prices that are readily and regularly available in an active market. The Company’s Level 2 investments are valued using third-party pricing sources based on observable inputs, such as quoted prices for similar assets at the measurement date; quoted prices in markets that are not active; or other inputs that are observable, either directly or indirectly.

The following table summarizes, by major security type, the Company's assets that are measured at fair value on a recurring basis and are categorized using the fair value hierarchy and where they are classified on the Consolidated Balance Sheets (in thousands):



	September 30, 2016
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Estimated Fair Value		Cash and cash equivalents		Short-term (1) investments		Long-term (2) investments
Cash	$	14,205	$	—	$	—		$	14,205	$	14,205	$	—	$	—
Level 1 securities:
Money market funds	18,682		—		—			18,682		18,682		—		—
Level 2 securities:
Corporate bonds	12,531		1		(7		)	12,525		—		12,525		—
Commercial paper	7,297		—		—			7,297		2,099		5,198		—
Agency bond	23,101		10		—			23,111		—		20,614		2,497
Total	$	75,816	$	11	$	(7	)	$	75,820	$	34,986	$	38,337	$	2,497

(1) Contractual maturity due within one year.

(2) Contractual maturity greater than one year.



	December 31, 2015
	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Estimated Fair Value		Cash and cash equivalents		Short-term investments		Long-term investments
Cash	$	10,302	$	—	$	—	$	10,302	$	10,302	$	—	$	—
Level 1 securities:
Money market funds	106,883		—		—		106,883		106,883		—		—
Total	$	117,185	$	—	$	—	$	117,185	$	117,185	$	—	$	—

Realized gains or losses and other-than-temporary impairments, if any, on available-for-sale securities are reported in other income (expense), net as incurred. The Company did not have material unrealized losses at September 30, 2016. There were no material gross realized gains or losses in the three and nine months ended September 30, 2016.

Note D—Accounts Receivable

Accounts receivable consisted of the following (in thousands):



	September 30, 2016			December 31, 2015
Total receivables	$	14,591		$	15,421
Allowance for doubtful accounts and returns	(752		)	(554		)
Accounts receivable, net	$	13,839		$	14,867

There were $34,000 and $88,000 write-offs related to accounts receivable for the three months ended September 30, 2016 and 2015, respectively, and $34,000 and $88,000 for the nine months ended September 30, 2016 and 2015, respectively.

Summary of allowance for doubtful accounts and returns activity was as follows (in thousands):



	September 30, 2016			December 31, 2015
Beginning balance	(554		)	(162		)
Provision for bad debts on trade receivables	(243		)	(359		)
Other allowances	11			(121		)
Accounts receivable write offs	34			88
Ending balance	$	(752	)	$	(554	)

Note E—Inventories

Inventories consisted of the following (in thousands):



	September 30, 2016		December 31, 2015
Raw Material	$	3,353	$	4,175
Work in process	2,232		2,683
Finished goods	6,170		4,662
Total Inventories	$	11,755	$	11,520

Note F—Accrued Expenses

Accrued expenses consisted of the following (in thousands):



	September 30, 2016		December 31, 2015
Accrued employee compensation	$	2,587	$	3,585
Deferred rent	149		213
Accrued legal expense	1,149		334
Accrued consulting expense	49		134
Accrued vendor charges	274		692
Accrued revenue share expense	863		932
Accrued patent settlement and license costs	—		500
Accrued clinical trial expense	123		302
Accrued other	1,052		1,119
	$	6,246	$	7,811

Note G—Commitments and Contingencies

Operating Leases - Real Estate

The Company maintains its corporate headquarters in a leased building located in Bedford, Massachusetts, and its manufacturing facility located in Wilmington, Massachusetts, all of which are accounted for as operating leases.

The Company leases the Bedford facility under a non-cancellable sublease that is scheduled to expire in April 2017. On September 19, 2016, the Company entered into a Lease (the “Billerica Lease”) with Technology Park X Limited Partnership, a Massachusetts limited partnership (the “Landlord”), for 45,043 square feet of office space in Billerica, Massachusetts. The term of the Billerica Lease commences on April 1, 2017 and expires on October 1, 2025, subject to extension or earlier termination as provided in the Billerica Lease. The Company expects the Billerica property will serve as the Company’s corporate headquarters beginning in April 2017.

Under the Billerica Lease, the Company will pay no monthly rent for the first six months and approximately $0.1 million per month for the following six months. After April 1, 2018, the Company’s monthly rent payments will increase annually by $0.50 per square foot. The Company also will be obligated to pay its pro rata share of certain

operating costs, including real estate taxes, under the Billerica Lease. In addition, the Company will post a customary letter of credit in the amount of approximately $0.5 million as a security deposit pursuant to the Billerica Lease, subject to three bi-annual reductions of $0.1 million each beginning on the first day of the 37th month after the Billerica Lease commences. Upon an event of default (as defined in the Billerica Lease), the Landlord may terminate the Billerica Lease and require the Company to pay the present value of the remaining rent that would have been payable during the remainder of the term of the Billerica Lease. The Billerica Lease also contains other customary default provisions, representations, warranties, and covenants.

The Company leases the Wilmington facility under a long-term, non-cancellable lease that commenced in April 2015 and will expire in July 2022 (the "Wilmington Lease"). On July 25, 2016, the Company entered into an amendment to the Wilmington Lease. Pursuant to the amendment, the Company exercised an option in its current lease to rent an additional 18,223 square feet of space adjacent to the Company’s existing premises. The Company is scheduled to take possession of the additional space in March 2017. The initial term of the Wilmington Lease for the existing premises and the additional space expires on July 31, 2022, and the Company has a right to extend the term for one additional five-year period. The initial base rental rate for the additional space is $0.2 million annually, subject to 2% annual increases until the expiration of the initial term.

Rent expense of $0.4 million and $0.5 million for the three months ended September 30, 2016 and 2015, respectively, and $1.1 million and $1.3 million for the nine months ended September 30, 2016 and 2015, respectively, was charged to operations. The Company’s operating lease agreements contain scheduled rent increases, which are being amortized over the terms of the agreements using the straight-line method.

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 its scientific advisory board and to assist with the development of the Company’s customized implant products and related intellectual property. These agreements provide that the Company will pay the advisor a specified percentage of the Company’s net revenues, 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, which the Company covered by a claim of one of its 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 revenues 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, 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.

Pursuant to the terms of an amended and restated revenue share agreement with Dr. Philipp Lang, the Company’s outgoing Chief Executive Officer and member of the Board of Directors, the specified percentage of the Company’s net revenues payable to Dr. Lang ranges from 0.875% to 1.33% and applies to all of the Company’s current and planned products, including the Company’s iUni, iDuo, iTotal Cr, iTotal PS and iTotal Hip products, as well as certain other knee, hip and shoulder replacement products and related instrumentation the Company may develop in the future. The Company’s payment obligations under this agreement expire on a product-by-product basis on the last to expire of the Company’s patents on which Dr. Lang is named an inventor that claim the applicable product. These payment obligations survive termination of Dr. Lang’s employment with the Company. The Company incurred revenue share expense paid to Dr. Lang of $230,000 and $168,000 for the three months ended September 30, 2016, and 2015, respectively, and $718,000 and $544,000 for the nine months ended September 30, 2016, and 2015, respectively.

The Company incurred aggregate revenue share expense including all amounts payable under the Company’s scientific advisory board and Chief Executive Officer revenue share agreements of $0.8 million during the three months ended September 30, 2016, representing 4.4% of product revenue, $2.6 million during the nine months ended September 30, 2016, representing 4.5% of product revenue, $0.7 million during the three months ended September 30, 2015, representing 5.1% of product revenue, and $2.2 million during the nine months ended September 30, 2015, representing 5.1% of product revenue. Revenue share expense is included in research and development. See “Note H—Related Party Transactions” for further information regarding the Company’s arrangement with its Chief Executive Officer.

Other obligations

In the ordinary course of business, the Company is a party to certain non-cancellable contractual obligations typically related to research and development and marketing services. 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.

Indemnifications

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 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 H—Related Party Transactions

Vertegen

In April 2007, the Company entered into a license agreement with Vertegen, Inc., or Vertegen, which was amended in May 2015 (the “Vertegen Agreement”). Vertegen is an entity that is wholly owned by Dr. Lang, the Company’s Chief Executive Officer. Under the Vertegen Agreement, Vertegen granted the Company an exclusive, worldwide license under specified Vertegen patent rights and related technology to make, use and sell products and services in the fields of diagnosis and treatment of articular disorders and disorders of the human spine. The company may sublicense the rights licensed to it by Vertegen. The Company is required to use commercially reasonable efforts, at its sole expense, to prosecute the patent applications licensed to the Company by Vertegen. Pursuant to the Vertegen Agreement, the Company is required to pay Vertegen a 6% royalty on net sales of products covered by the patents licensed to the Company by Vertegen, the subject matter of which is directed primarily to spinal implants, and any proceeds from the Company enforcing the patent rights licensed to the Company by Vertegen. Such 6% royalty rate will be reduced to 3% in the United States during the five-year period following the expiration of the last-to-expire applicable patent in the United States and in the rest of the world during the five-year period following the expiration of the last-to-expire patent anywhere in the world. The Company has not sold any products subject to this agreement and has paid no royalties under this agreement. The Company has cumulatively paid approximately $150,000 and $140,000 in expenses as of September 30, 2016 and September 30, 2015, respectively, in connection with the filing and prosecution of the patent applications licensed to the Company by Vertegen. The Vertegen Agreement may be terminated by the Company at any time by providing notice to Vertegen. In addition, Vertegen may terminate the Vertegen Agreement in its entirety if the Company is in material breach of the agreement, and the Company fails to cure such breach during a specified period.

Revenue share agreement

As described in "Note G-Commitments and Contingencies", the amended and restated revenue share agreement with Dr. Philipp Lang, the Company’s outgoing Chief Executive Officer and member of the Board of Directors, provides that the Company will pay Dr. Lang a specified percentage of its net revenues, ranging from

0.875% to 1.33%, with respect to all of its current and planned products, including the Company’s iUni, iDuo, iTotal CR, iTotal PS and iTotal Hip products, as well as certain other knee, hip and shoulder replacement products and related instrumentation the Company may develop in the future. The specific percentage is determined by reference to product classifications set forth in the agreement and is tiered based on the level of net revenues collected by the Company on such product sales. The Company’s payment obligations expire on a product-by-product basis on the last to expire of the Company’s patents on which Dr. Lang is a named inventor that claim the applicable product. These payment obligations survive any termination of Dr. Lang’s employment with the Company. The Company incurred revenue share expense paid to Dr. Lang of $230,000 and $168,000 and for the three months ended September 30, 2016 and 2015, respectively, and $718,000 and $544,000 for the nine months ended September 30, 2016 and 2015, respectively.

Note I—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. The holder of each share of common stock is entitled to one vote.

Summary of common stock activity was as follows:



		Shares
Outstanding December 31, 2015		41,110,127
Issuance of common stock - option exercises		883,278
Issuance of restricted common stock		765,288
Outstanding September 30, 2016		42,758,693

Common stock warrants

The Company issued warrants to certain investors and consultants to purchase 1,138,424 shares of common stock at an exercise price range of $0.02 to $9.00 per share. Additionally, certain warrants to purchase shares of preferred stock were converted upon the closing of the Company's IPO to warrants to purchase 564,188 shares of common stock. Warrants to purchase 671,779 and 751,779 shares of common stock were outstanding as of September 30, 2016 and December 31, 2015, respectively.

As of September 30, 2016 and December 31, 2015, the weighted average warrant exercise prices 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, 2015	751,779		$	10.30	1.33	751,779		$	10.30
Cancelled/expired	(80,000	)	12.00		—	(80,000	)	12.00
Outstanding September 30, 2016	671,779		$	10.10	0.67	671,779		$	10.10

Stock option plans

As of September 30, 2016, 1,500,790 shares of common stock were available for future issuance under the 2015 Stock Incentive Plan ("2015 Plan").

Stock option activity under all stock option plans was as follows:



	Number of Options		Weighted Average Exercise Price per Share
Outstanding December 31, 2015	5,248,329		$	5.56
Granted	—		—
Exercised	(883,278	)	2.50
Expired	(52,157	)	9.14
Cancelled/Forfeited	(82,129	)	9.59
Outstanding September 30, 2016	4,230,765		$	6.08
Total vested and exercisable	3,758,959		$	5.53

The total intrinsic value of awards exercised during the three and nine months ended September 30, 2016 was $2.2 million and $5.0 million, respectively. The total fair value of awards that vested during the three and nine

months ended September 30, 2016 was $0.5 million and $1.5 million, respectively. The weighted average remaining contractual term for the total stock options outstanding was 5.03 years as of September 30, 2016. The weighted average remaining contractual term for the total stock options vested and exercisable was 4.67 years as of September 30, 2016.

Restricted common stock award activity under the plan was as follows:



	Number of Shares		Weighted Average Fair Value
Unvested December 31, 2015	174,530		$	22.31
Granted	828,839		8.60
Vested	(30,750	)	12.86
Forfeited	(63,551	)	11.82
Unvested September 30, 2016	909,068		$	10.86

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.

There were no options granted for the nine months ended September 30, 2016.

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 September 30,		Nine Months Ended September 30,
	2016	2015	2016	2015
Risk-free interest rate	N/A	1.77	N/A	1.37% - 1.77%
Expected term (in years)	N/A	6.25	N/A	5.47 - 6.45
Dividend yield	N/A	—%	N/A	—%
Expected volatility	N/A	49.00%	N/A	49.00% - 50.00%

Employee stock-based compensation expense recognized was $1.4 million and $0.7 million for the three months ended September 30, 2016 and 2015, and $3.5 million and $2.6 million for the nine months ended September 30, 2016 and 2015. 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.

As of September 30, 2016, the Company had $2 million of total unrecognized compensation expense for options that will be recognized over a weighted average period of 1.63 years. As of September 30, 2016, the Company had $8 million of total unrecognized compensation expense for restricted awards that will be recognized over a weighted average period of 2.57 years.

Note J—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 predominately of Europe (including the United Kingdom). In general, sales are attributable to a geographic area based upon the customer’s country of domicile. Certain customers in Europe that are located outside of Germany are serviced by the Company's German subsidiary and revenues from those customers are attributable to Germany. Net property, plant and equipment are based upon physical location of the assets.

Geographic information consisted of the following (in thousands):



	Three Months Ended September 30,				Nine Months Ended September 30,
	2016		2015		2016	2015
Product Revenue
United States	$	14,954	$	10,466	44,663	32,596
Germany	3,026		2,499		11,398	10,012
Rest of World	420		525		1,425	1,345
	$	18,400	$	13,490	57,486	43,953



	September 30, 2016		December 31, 2015
Property and equipment, net
United States	$	14,870	$	10,836
Germany	115		130
Rest of World	—		—
	$	14,985	$	10,966

Note K—Subsequent Events

On October 24, 2016, the Company announced Mark A. Augusti’s appointment as President and Chief Executive Officer of the Company, effective as of the date he commences his employment on November 14, 2016 (the “Effective Date”). The Company expects that he will be appointed to the Company’s Board of Directors following the commencement of his employment. Mr. Augusti will succeed Philipp Lang, M.D. MBA, as President and Chief Executive Officer of the Company on the Effective Date, and Dr. Lang will continue to serve on the Company's Board of Directors.

In connection with Mr. Augusti’s employment, the Company entered into a letter agreement, dated October 19, 2016 (the “Employment Agreement”) which sets forth certain terms of Mr. Augusti’s employment. Pursuant to the terms of the Employment Agreement, Mr. Augusti will receive an annual base salary of $520,000. In addition, he will receive a one-time signing bonus of $200,000 and will be eligible to receive an annual performance bonus targeted at up to 75% of Mr. Augusti’s annual base salary. The actual performance bonus percentage is discretionary and will be subject to the Company's Board of Directors' assessment of Mr. Augusti’s performance as well as general business conditions at the Company. Mr. Augusti will not receive an annual performance bonus for fiscal year 2016. In addition, Mr. Augusti will be eligible to receive new hire equity grants and annual long-term incentive equity grants. Upon the commencement of his employment, Mr. Augusti will be eligible to receive an option to purchase shares of the Company’s common stock having a value up to $600,000 under the Company’s stock incentive plan (the “Plan”), and also will be eligible to receive a performance-based grant of shares of the Company’s common stock, subject to the achievement of certain specified performance-based milestones, having a value up to $600,000 under the Plan. Beginning in the 2017 calendar year, Mr. Augusti will be eligible to receive annual long-term incentive equity awards, with the initial award having an aggregate target value of up to $800,000 under the Company’s long-term incentive program. Mr. Augusti will be also be eligible to participate in all customary employee benefit plans or programs of the Company generally available to the Company’s full-time employees and/or executive officers. Additionally, the Employment Agreement provides that Mr. Augusti’s employment with the Company is at will and may be terminated by either party at any time for any or no reason or cause. In the event Mr. Augusti’s employment is terminated without cause, Mr. Augusti will be entitled to receive severance pay in the

form of salary continuation on the Company’s standard payroll dates following the termination date, a bonus payment, and, upon a qualifying termination within two years of a change of control, accelerated vesting of his unvested equity grants. Mr. Augusti will also receive a continuation of group health insurance coverage through COBRA with the cost of such benefits to be shared in the same relative proportion by the Company and Mr. Augusti as in effect on the date of termination.

The description of the Employment Agreement is qualified in its entirety by reference to the text of the Employment Agreement, a copy of which will be filed with the Company’s Annual Report on Form 10-K for the year ending December 31, 2016.

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, 2015. 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 this Quarterly Report on Form 10-Q, 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, plans and objectives of management 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 iTotal CR, our iTotal PS and, if we receive required marketing clearances or approvals, our iTotal Hip;


•	our expectations regarding our sales, expenses, gross margins 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;


•	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;


•	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;


•	the impact of our voluntary recall initiated in August 2015 on our business operations, financial results and customer relations;


•	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;


•	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 impact of federal legislation to reform the United States healthcare system and the reimposition of the 2.3 percent medical device excise tax if and when the current moratorium is lifted;


•	the anticipated adequacy of our capital resources to meet the needs of our business; and


•	our expectations regarding the time during which we will be an emerging growth company under the JOBS Act;


•	our plans and expectations related to our management transition and our new President and Chief

Executive Officer; and


•	our plans related to the move of our offices from Bedford, Massachusetts to Billerica, Massachusetts.

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 "Item 1A. Risk Factors" in our Annual Report on Form 10-K for the year ended December 31, 2015 and in this Quarterly Report on Form 10-Q, 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.

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 that are individually sized and shaped, which we refer to as customized, to fit each patient’s unique anatomy. The worldwide market for joint replacement products is approximately $15 billion annually and growing, and we believe our iFit technology platform is applicable to all major joints in this market. We believe we are the only company offering a broad line of customized knee implants designed to restore the natural shape of a patient’s knee. We have sold more than 50,000 knee implants in the United States and Europe. In clinical studies, iTotal CR, our cruciate-retaining total knee replacement implant and best-selling product, demonstrated superior clinical outcomes, including better function and greater patient satisfaction compared to traditional, off-the-shelf implants. In February 2015, we initiated the limited launch of iTotal PS, our posterior-stabilized total knee replacement implant which addresses the largest segment of the knee replacement market and we initiated the broad commercial launch of the iTotal PS in March 2016.

Our iFit technology platform comprises three key elements:


•	iFit Design, our proprietary algorithms and computer software that we use to design customized 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 customized 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 the manufacture of certain components of our customized 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 traditional, off-the-shelf implants.

All of our knee 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 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, and Hong Kong. In order for surgeons to use our products, the medical facilities where these surgeons treat patients typically require us to enter into purchasing contracts. The process of negotiating a purchasing contract 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 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.

In April 2015, we entered into a worldwide license agreement with MicroPort Orthopedics Inc., or MicroPort, a wholly owned subsidiary of MicroPort Scientific Corporation. Under the terms of this license agreement, we granted a perpetual, irrevocable, non-exclusive license to MicroPort to use patient-specific instrument technology covered by our patents and patent applications with off-the-shelf implants in the knee. This license does not extend to patient-specific implants. This license agreement provides for the payment to us of a fixed royalty at a high single to low double digit percentage of net sales on patient-specific instruments and associated implant components in the knee, including MicroPort’s Prophecy patient-specific instruments used with its Advance and Evolution implant components. We cannot be certain as to the timing or amount of payment of any royalties under this license agreement. This license agreement also provided for a single lump-sum payment by MicroPort to us of low-single digit millions of dollars upon entering into the license agreement, which has been paid. This license agreement will expire upon the expiration of the last to expire of our patents and patent applications licensed to MicroPort, which currently is expected to occur in 2029.

In April 2015, we entered into a fully paid up, worldwide license agreement with Wright Medical Group, Inc., or Wright Group, and its wholly owned subsidiary Wright Medical Technology, Inc., or Wright Technology and collectively with Wright Group, Wright Medical. Under the terms of this license agreement, we granted a perpetual, irrevocable, non-exclusive license to Wright Medical to use patient-specific instrument technology covered by our patents and patent applications with off-the-shelf implants in the foot and ankle. This license does not extend to patient-specific implants. This license agreement provided for a single lump-sum payment by Wright Medical to us of mid-single digit millions of dollars upon entering into the license agreement, which has been paid. This license agreement will expire upon the expiration of the last to expire of our patents and patent applications licensed to Wright Medical, which currently is expected to occur in 2031.

We have accounted for the agreements with Wright Medical and MicroPort under ASC 605-25, Multiple-Element Arrangements and Staff Accounting Bulletin No. 104, Revenue Recognition (ASC 605). In accordance with ASC 605, we were required to identify and account for each of the separate units of accounting. We identified the relative selling price for each and then allocated the total consideration based on their relative values. In connection with these agreements, in April 2015, we recognized in aggregate (i) back-owed royalties of $3.4 million as royalty revenue and (ii) the value attributable to the settlements of $0.2 million as other income. Additionally, we recognized an initial $5.1 million in aggregate as deferred royalty revenue, which is recognized as royalty revenue ratably through 2031. The on-going royalty from MicroPort is recognized as royalty revenue upon receipt of payment.

On August 31, 2015, we announced a voluntary recall of specific serial numbers of patient-specific instrumentation for our iUni, iDuo, iTotal CR and iTotal PS knee replacement product systems. The recalled products were manufactured and distributed from our Wilmington manufacturing facility between July 18, 2015 and August 28, 2015. We isolated the root cause to a step in our ethylene oxide sterilization process conducted by a vendor. We have since completed final testing and implemented corrective actions, and we resumed normal production in October 2015. Our voluntary recall announced on August 31, 2015 has adversely affected our business and may continue to adversely affect our business in a number of ways, including through the financial impact from lost sales of the recalled products, reduction of our production capacity over the period of our investigation and resolution of the root cause of the recall, commercial disruption, slower than expected ramp in new orders and damage to our reputation with orthopedic surgeons, consumers, healthcare providers, distributors and other business partners.

Cost of revenue

We produce all of our computer aided designs, or CAD, in-house and use them to direct all of our product manufacturing efforts. Until July 2015, we manufactured all of our patient-specific instruments, or iJigs, in our facilities in Burlington and Wilmington, Massachusetts. Since August 2015, we have manufactured all of our iJigs in our Wilmington facility. We also make in our facilities certain tibial components used in our implants. We outsource the production of the remainder of the tibial components and the manufacture of femoral and other implant components to third-party suppliers. Our suppliers make the remainder of our customized implant components using the CAD designs we supply. Cost of revenue consists primarily of cost of raw materials, manufacturing personnel, manufacturing supplies, inbound freight and manufacturing overhead and depreciation expense.

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, the geographic mix of sales, product sales mix, the number of cancelled sales orders and royalty revenue.

We expect our gross margin from the sale of our products, which excludes royalty revenue, to expand over time to the extent we are successful in reducing our manufacturing costs per unit and increasing our manufacturing efficiency as sales volume increases. We believe that areas of opportunity to expand our gross margins 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;


•	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;


•	developing new versions of our software used in the design of our customized joint replacement implants, which we believe will reduce costs associated with the design process; and


•	obtaining more favorable pricing of certain components of our products manufactured for us by third parties.

We continue to explore the application of our 3D printing technology to select metal components of our products, which we believe may be a future opportunity for reducing our manufacturing costs. We also plan 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.

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, 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 and educating surgeons about the benefits of our products are required to generate and grow revenue. We expect sales and marketing expense to significantly 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 prototypes, testing, clinical study programs and regulatory activities, contractors and consultants, and equipment and software to support our development. As our revenue increases, we will also incur additional expenses for revenue share payments to our past and present scientific advisory board members, including our Chief Executive Officer. 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, general legal and intellectual property, 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, medical device tax 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 a public company. We anticipate increased expenses associated with being a public company will include increases in audit, legal, regulatory and tax-related services associated with maintaining compliance with exchange listing and SEC requirements, business insurance premiums and investor relations costs. As our revenue increases we also will 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.

Other income (expense), net

Other income (expense), net consists primarily of interest expense and amortization of debt discount associated with our term loans and realized gains (losses) from foreign currency transactions. The effect of exchange rates on our foreign currency-denominated asset and liability balances are recorded in other income (expense) and are recorded as foreign currency translation 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.

Consolidated results of operations

Comparison of the three months ended September 30, 2016 and 2015

The following table sets forth our results of operations expressed as dollar amounts, percentage of total revenue and year-over-year change (in thousands):



	2016					2015					2016 vs 2015
Three Months Ended September 30,	Amount			As a% of Total Revenue		Amount			As a% of Total Revenue		$ Change			% Change
Revenue
Product revenue	$	18,400		99	%	$	13,490		97	%	$	4,910		36	%
Royalty	243			1		404			3		(161		)	(40	)
Total revenue	18,643			100		13,894			100		4,749			34
Cost of revenue	12,645			68		11,132			80		1,513			14
Gross profit	5,998			32		2,762			20		3,236			117

Operating expenses:
Sales and marketing	9,301			50		9,433			68		(132		)	(1	)
Research and development	4,099			22		3,885			28		214			6
General and administrative	5,503			30		5,656			41		(153		)	(3	)
Total operating expenses	18,903			101		18,974			137		(71		)	—
Loss from operations	(12,905		)	(69	)	(16,212		)	(117	)	3,307			20
Total other income/(expenses), net	157			1		(887		)	(6	)	1,044			118
Loss before income taxes	(12,748		)	(68	)	(17,099		)	(123	)	4,351			25
Income tax provision	14			—		8			—		6			75
Net loss	$	(12,762	)	(68	)%	$	(17,107	)	(123	)%	$	4,345		25	%

Product revenue. Product revenue was $18.4 million for the three months ended September 30, 2016 compared to $13.5 million for the three months ended September 30, 2015, which was affected by our product recall, an increase of $4.9 million or 36%, due principally to increased sales of our primary total knee products, iTotal CR and iTotal PS.

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):



	2016				2015				2016 vs 2015
Three Months Ended September 30,	Amount		As a % of Product Revenue		Amount		As a % of Product Revenue		$ Change			% Change
United States	$	14,954	81	%	$	10,466	78	%	$	4,488		43	%
Germany	3,026		16		2,499		19		$	527		21
Rest of world	420		3		525		3		(105		)	(20	)
Product revenue	$	18,400	100	%	$	13,490	100	%	$	4,910		36	%

Royalty revenue. In April 2015, we entered into a fully paid up, worldwide license agreement with Wright Medical for a single lump-sum payment by Wright Medical to us upon entering into the agreement. At the same time we also entered into a worldwide license agreement with MicroPort for a lump-sum payment by MicroPort to us upon entering into the license agreement. Royalty revenue related to these agreements was $0.2 million for the

three months ended September 30, 2016 compared to $0.4 million for the three months ended September 30, 2015. The decrease in royalty revenue was due to the timing of payments received and recognized as royalty revenue in the three months ended September 30, 2016 compared to the three months ended September 30, 2015.

Cost of revenue, gross profit and gross margin. Cost of revenue was $12.6 million for the three months ended September 30, 2016 compared to $11.1 million for the three months ended September 30, 2015, which was affected by our product recall, an increase of $1.5 million or 14%. The increase was due primarily to an increase in production and personnel costs associated with the increase in product revenue, partially offset by vertical integration and other cost saving initiatives. Gross profit was $6.0 million for the three months ended September 30, 2016 compared to $2.8 million for the three months ended September 30, 2015, an increase of $3.2 million or 117%. Gross margin increased 1200 basis points to 32% for the three months ended September 30, 2016 from 20% for the three months ended September 30, 2015. This increase in gross margin was driven primarily by higher product revenue, vertical integration, and other cost saving initiatives, offset by an increase in the cost of unused product as a result of cancelled sales orders, and a decrease in royalty revenue. The cost of unused product was $1.3 million and $0.8 million for the three months ended September 30, 2016 and 2015, respectively.

Sales and marketing. Sales and marketing expense was $9.3 million for the three months ended September 30, 2016 compared to $9.4 million for the three months ended September 30, 2015, a decrease of $0.1 million or 1%. The decrease was due to a $0.5 million decrease in surgeon training related expense and a $0.2 million decrease in travel expenses, offset by a $0.6 million increase in sales commissions as a result of the increase in product revenue. Sales and marketing expense decreased as a percentage of total revenue to 50% for the three months ended September 30, 2016 from 68% for the three months ended September 30, 2015.

Research and development. Research and development expense was $4.1 million for the three months ended September 30, 2016 compared to $3.9 million for the three months ended September 30, 2015, an increase of $0.2 million or 6%. The increase was due to a $0.1 million increase in revenue share as a result of higher product revenues, as well as an increase of $0.1 million in consulting fees compared to the previous three months ended September 30, 2015. Research and development expense decreased as a percentage of total revenue to 22% for the three months ended September 30, 2016 from 28% for the three months ended September 30, 2015.

General and administrative. General and administrative expense was $5.5 million for the three months ended September 30, 2016 compared to $5.7 million for the three months ended September 30, 2015, a decrease of $0.2 million or 3%. The decrease was due primarily to a $0.4 million decrease in facility costs, $0.3 million decrease in bank fees, a $0.2 decrease in medical device tax, and a $0.1 million decrease in freight costs, offset by a $0.6 million increase in legal expenses related to litigation and other legal expenses and an increase of $0.2 million in personnel costs. General and administrative expense decreased as a percentage of total revenue to 30% for the three months ended September 30, 2016 from 41% for the three months ended September 30, 2015.

Other income/(expense), net. Other income/(expense), net was $0.2 million net other income for the three months ended September 30, 2016 compared to $(0.9) million net other expense for the three months ended September 30, 2015, a net other income increase of $1.0 million, or 118%. The change was primarily due to an increase in interest income as a result of an increase in investments and a decrease in interest expense as a result of paying off long-term debt.

Income taxes. Income tax provision was $14,000 and $8,000 for the three months ended September 30, 2016 and 2015, 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.

Comparison of the nine months ended September 30, 2016 and 2015

The following table sets forth our results of operations expressed as dollar amounts, percentage of total revenue and year-over-year change (in thousands):



	2016					2015					2016 vs 2015
Nine Months Ended September 30,	Amount			As a% of Total Revenue		Amount			As a% of Total Revenue		$ Change			% Change
Revenue
Product revenue	$	57,486		99	%	$	43,953		92	%	$	13,533		31	%
Royalty	740			1		3,863			8		(3,123		)	(81	)
Total revenue	58,226			100		47,816			100		10,410			22
Cost of revenue	39,564			68		32,371			68		7,193			22
Gross profit	18,662			32		15,445			32		3,217			21

Operating expenses:
Sales and marketing	31,063			53		27,584			58		3,479			13
Research and development	12,474			21		12,218			26		256			2
General and administrative	17,285			30		16,790			35		495			3
Total operating expenses	60,822			104		56,592			118		4,230			7
Loss from operations	(42,160		)	(72	)	(41,147		)	(86	)	(1,013		)	(2	)
Total other income/(expenses), net	339			1		(1,080		)	(2	)	1,419			131
Loss before income taxes	(41,821		)	(72	)	(42,227		)	(88	)	406			1
Income tax provision	27			—		29			—		(2		)	(7	)
Net loss	$	(41,848	)	(72	)%	$	(42,256	)	(88	)%	$	408		1	%

Product revenue. Product revenue was $57.5 million for the nine months ended September 30, 2016 compared to $44.0 million for the nine months ended September 30, 2015, which was affected by our product recall, an increase of $13.5 million or 31%, due principally to increased sales of our primary total knee products, iTotal CR and iTotal PS.

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):



	2016				2015				2016 vs 2015
Nine Months Ended September 30,	Amount		As a % of Product Revenue		Amount		As a % of Product Revenue		$ Change		% Change
United States	$	44,663	78	%	$	32,596	74	%	$	12,067	37	%
Germany	11,398		20		10,012		23		$	1,386	14
Rest of world	1,425		2		1,345		3		80		6
Product revenue	$	57,486	100	%	$	43,953	100	%	$	13,533	31	%

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 78% for the nine months ended September 30, 2016 compared to 74% for the nine months ended September 30, 2015. We believe the lower level of revenue as a percentage of product revenue outside the United States in the nine months ended September 30, 2016 was due to the introduction of the iTotal PS in the United States, partially offset by the increase in exchange rate for Germany.

upon entering into the agreement. Royalty revenue related to these agreements was $0.7 million for the nine months ended September 30, 2016 compared to $3.9 million for the nine months ended September 30, 2015. The decrease in royalty revenue was due to the $3.5 million of back-owed royalties recognized in the three months ended September 30, 2015.

Cost of revenue, gross profit and gross margin. Cost of revenue was $39.6 million for the nine months ended September 30, 2016 compared to $32.4 million for the nine months ended September 30, 2015, which was affected by our product recall, an increase of $7.2 million or 22%. The increase was due primarily to an increase in production and personnel costs associated with the increase in product revenue. Gross profit increased by $3.2 million or 21%, to $18.7 million for the nine months ended September 30, 2016 compared to $15.4 million for the nine months ended September 30, 2015, due to higher product revenue offset by the decrease in royalty revenue. Gross margin was 32% for the nine months ended September 30, 2016 and 2015.

Sales and marketing. Sales and marketing expense was $31.1 million for the nine months ended September 30, 2016 compared to $27.6 million for the nine months ended September 30, 2015, an increase of $3.5 million or 13%. The increase was due primarily to a $2.7 million increase in sales commissions as a result of the increase in product revenue, an increase of $0.9 million in personnel expenses, and a $0.7 million increase in other sales and marketing related expenses, offset by a decrease of $0.4 million in surgeon training related expenses, and $0.4 million in marketing and promotional expenses. Sales and marketing expense decreased as a percentage of total revenue to 53% for the nine months ended September 30, 2016 from 58% for the nine months ended September 30, 2015.

Research and development. Research and development expense was $12.5 million for the nine months ended September 30, 2016 compared to $12.2 million for the nine months ended September 30, 2015, an increase of $0.3 million or 2%. The increase was due primarily to a $0.4 million increase in prototype parts expenses, a $0.3 million increase in revenue share expense, offset by $0.4 million decrease in of various other expenses. Research and development expense decreased as a percentage of total revenue to 21% for the nine months ended September 30, 2016 from 26% for the nine months ended September 30, 2015.

General and administrative. General and administrative expense was $17.3 million for the nine months ended September 30, 2016 compared to $16.8 million for the nine months ended September 30, 2015, an increase of $0.5 million or 3%. The increase was due primarily to a $2.4 million increase in legal costs related to litigation and other legal expenses, an increase of $0.4 million in director and officers insurance, and an increase of $0.3 million in software expense, offset by a $0.7 million decrease in freight costs, a $0.7 million decrease in facility costs, a $0.6 million decrease in medical device tax, a $0.3 million decrease in bank fees, and a $0.3 million decrease in personnel costs. General and administrative expense decreased as a percentage of total revenue to 30% for the nine months ended September 30, 2016 from 35% for the nine months ended September 30, 2015.

Other income/(expense), net. Other income/(expense), net was $0.3 million net other income for the nine months ended September 30, 2016 compared to $(1.1) million net other expense for the nine months ended September 30, 2015, a net other income increase of $1.4 million, or 131%. The increase was primarily due to an increase in interest income as a result of an increase in investments and a decrease in interest expense as a result of paying off long-term debt.

Income taxes. Income tax provision was approximately $27,000 and $29,000 for the nine months ended September 30, 2016 and 2015, 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.

Liquidity, capital resources and plan of operations

Sources of liquidity and funding requirements

From our inception in June 2004 through the nine months ended September 30, 2016, we have financed our operations through private placements of preferred stock, our initial public offering, or IPO, bank debt and convertible debt financings, equipment purchase loans and product revenue beginning in 2007. Our product revenue has continued to grow from year-to-year; however, we have not yet attained profitability and continue to incur operating losses. As of September 30, 2016, we had an accumulated deficit of $367.2 million.

On July 7, 2015, we closed our IPO of our common stock and issued and sold 10,350,000 shares of our common stock, including 1,350,000 shares of common stock issued upon the exercise in full by the underwriters of their over-allotment option, at a public offering price of $15.00 per share, for aggregate offering proceeds of approximately $155 million. We received aggregate net proceeds from the offering of approximately $140 million after deducting underwriting discounts and commissions and offering expenses payable by us. Our common stock began trading on the NASDAQ Global Select Market on July 1, 2015.

In June 2011, we entered into a $1.4 million secured term loan facility with the Massachusetts Development Financing Agency, referred to as the MDFA facility, to finance equipment purchases, of which $0.3 million was outstanding as of September 30, 2016 and $0.5 million was outstanding as of December 31, 2015. We are scheduled to make monthly interest and principal payments for the MDFA facility through July 2017.

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.

In addition, our general and administrative expense will increase due to the additional operational and reporting costs associated with our expanded operations and being a public company.

We anticipate that our principal sources of funds in the future will be revenue generated from the sales of our products and revenues that we may generate in connection with licensing our intellectual property. 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.

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 sale 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.

As of September 30, 2016, we had cash and cash equivalents and short-term and long-term investments of $75.8 million and $0.3 million in restricted cash allocated to lease deposits. Based on our current operating plan, we expect that our existing cash and cash equivalents and investments as of September 30, 2016 and anticipated revenue from operations, including from projected sales of our products, will enable us to fund our operating expenses and capital expenditure requirements for at least the next 12 months. 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 and the gross profit we expect to generate from those revenues, and we could use our capital resources sooner than we expect.

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 between periods (in thousands):



	Nine Months Ended September 30,
	2016			2015			$ Change			% Change
Net cash (used in) provided by:
Operating activities	$	(36,840	)	$	(33,499	)	$	(3,341	)	(10	)%
Investing activities	(47,048		)	51			(47,099		)	(92,351	)
Financing activities	1,989			134,596			(132,607		)	(99	)
Effect of exchange rate on cash	(300		)	154			(454		)	(295	)
Total	$	(82,199	)	$	101,302		$	(183,501	)	(181	)%

Net cash used in operating activities. Net cash used in operating activities was $36.8 million for the nine months ended September 30, 2016 and $33.5 million for the nine months ended September 30, 2015, an increase of $3.3 million. These amounts primarily reflect net loss of $41.8 million for the nine months ended September 30, 2016 and $42.3 million for the nine months ended September 30, 2015. The net cash used in operating activities for the nine months ended September 30, 2016 was affected by changes in our operating assets and liabilities, including $4.1 million related to accounts payable and accrued liabilities, $5.2 million related to deferred royalty revenue, $1.2 million related to prepaid expenses, $0.1 million related to accounts receivable, $2.7 million related to inventory, as well as an increase of $0.9 million in stock compensation expense, an increase of $0.4 million in depreciation expense, an increase in amortization/accretion on investments of $0.2 million, and an increase of $0.1 million in impairment of long-term assets.

Net cash used in investing activities. Net cash used in investing activities was $47.0 million for the nine months ended September 30, 2016 and $0.1 million for the nine months ended September 30, 2015, an increase of $47.1 million. These amounts primarily reflect an increase in investments of $57.6 million as well as an increase in costs related to the acquisition of property, plant, and equipment of $2.6 million, offset by an increase in matured investments of $16.5 million and a decrease of restricted cash of $3.4 million.

Net cash provided by financing activities. Net cash provided by financing activities was $2.0 million for the nine months ended September 30, 2016 and $134.6 million for the nine months ended September 30, 2015, a decrease of $132.6 million. The decrease was due to a decrease in net proceeds from issuance of common stock of $139.8 million and a decrease in net proceeds from the exercise of preferred stock warrants of $4.5 million, offset by a decrease in debt payments of $10.0 million and an increase in net proceeds from the exercise of common stock options of $1.7 million.

Contractual obligations and commitments

We described our contractual obligations and commitments under 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, 2015. Subsequently, on September 19, 2016, we entered into the Billerica Lease for 45,043 square feet of office space in Billerica, Massachusetts. The term of the Billerica Lease commences on April 1, 2017 and expires on October 1, 2025, subject to extension or earlier termination as provided in the Billerica Lease. The

Company expects the Billerica property will serve as the Company’s corporate headquarters beginning in April 2017.

Under the Billerica Lease, we will pay no monthly rent for the first six months and approximately $0.1 million per month for the following six months. After April 1, 2018, our monthly rent payments will increase annually by $0.50 per square foot. We also will be obligated to pay our pro rata share of certain operating costs, including real estate taxes, under the Billerica Lease. In addition, we will post a customary letter of credit in the amount of approximately $0.5 million as a security deposit pursuant to the Billerica Lease, subject to three bi-annual reductions of $0.1 million each beginning on the first day of the 37th month after the Billerica Lease commences. Upon an event of default (as defined in the Billerica Lease), the Landlord may terminate the Billerica Lease and require us to pay the present value of the remaining rent that would have been payable during the remainder of the term of the Billerica Lease. The Billerica Lease also contains other customary default provisions, representations, warranties, and covenants.

On July 25, 2016, we entered into an amendment to the Wilmington Lease. Pursuant to the amendment, we exercised an option in our current lease to rent an additional 18,223 square feet of space adjacent to our existing premises. We are scheduled to take possession of the additional space in March 2017. The initial term of the Wilmington Lease for the existing premises and the additional space expires on July 31, 2022, and we have a right to extend the term for one additional five-year period. The initial base rental rate for the additional space is $0.2 million annually, subject to 2% annual increases until the expiration of the initial term.

Off-balance sheet arrangements

Through September 30, 2016, 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 U.S. GAAP. 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 as of 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, intangible valuation, equity instruments, impairment assessments, income tax reserves and related allowances, and the lives of property and equipment. 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 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, 2015 and Note B to the consolidated financial statements appearing in this Quarterly Report on Form 10-Q.

Recent accounting pronouncements

Information with respect to recent accounting developments is provided in Note B to the consolidated financial statements appearing in this Quarterly Report on Form 10-Q.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

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

Interest rate risk

We are exposed to limited market risk related to fluctuation in interest rates and market prices. Our primary exposure to market risk is interest rate sensitivity, which is affected by changes in the general level of U.S. interest rates. As of September 30, 2016, we had cash and cash equivalents of $35.0 million consisting of demand deposits and money market accounts on deposit with certain financial institutions and $40.8 million in investments consisting of a variety of securities of high credit quality including U.S. treasury bonds, corporate bonds, commercial paper and agency bonds. The primary objective of our investment activities is to preserve our capital to fund our operations. Our investments may be subject to interest rate risk and could fall in value. However, because our investments are primarily short-term in duration, we believe that our exposure to interest rate risk is not significant. Additionally, we had $2.5 million as of September 30, 2016 and $2.1 million as of December 31, 2015 held in foreign bank accounts that were not federally insured. A hypothetical 100 basis point change in interest rates during any of the periods presented would not have had a material impact on our consolidated financial statements.

Foreign currency exchange risk

Fluctuations in the rate of exchange between the U.S. dollar and foreign currencies could adversely affect our financial results. Approximately 22% of our product revenue for the nine months ended September 30, 2016 and 26% of our product revenue for the nine months ended September 30, 2015 were denominated in foreign currencies. We expect that foreign currencies will continue to represent a similarly significant percentage of our net sales in the future. Costs of revenue related to these sales are primarily denominated in U.S. dollars; however, operating costs, including sales and marketing and general and administrative expense, related to these sales are largely denominated in the same currencies as the sales, thereby partially limiting our transaction risk exposure. Additionally, fluctuations in foreign currency exchange rates may cause us to recognize transaction gains and losses in our statement of operations. To date, foreign currency transaction realized gains and losses have not been material to our consolidated financial statements, and we have not engaged in any foreign currency hedging transactions. As our international operations grow, we will continue to reassess our approach to managing the risks relating to fluctuations in currency rates. A 10% increase or decrease in foreign currency exchange rates would have resulted in additional income or expense of $0.3 million for the nine months ended September 30, 2016 and 2015.

We do not believe that inflation and change in prices had a significant impact on our results of operations for any periods presented in our consolidated financial statements.

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 September 30, 2016. 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 September 30, 2016, 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 quarter ended September 30, 2016 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

ITEM 1. LEGAL PROCEEDINGS

In the course of our manufacture and sale of joint replacement products, we are subject to routine risk of product liability, patent infringement and other claims in the United States and in other countries where we sell our products.

On September 3, 2015, a purported securities class action lawsuit was filed against us, our Chief Executive Officer, and Chief Financial Officer in the United States District Court for the District of Massachusetts. The complaint was brought on behalf of an alleged class of those who purchased our common stock in connection with our initial public offering or on the open market between July 1, 2015 and August 28, 2015, which we refer to as the class period. On January 11, 2016, a consolidated amended complaint was filed purporting to allege claims arising under Sections 11 and 15 of the Securities Act of 1933, as amended, Sections 10(b) and 20(a) of the Securities Exchange Act of 1934, as amended, and Rule 10b-5 promulgated thereunder, including allegations that our stock was artificially inflated during the class period because the defendants allegedly made misrepresentations or did not make proper disclosures regarding our manufacturing process prior to our voluntary recall of specific serial numbers of patient-specific instrumentation for certain of our knee replacement product systems. The complaint sought, among other relief, certification of the class, unspecified compensatory damages, interest, attorneys’ fees, expert fees and other costs. On March 18 2016, we filed a motion to dismiss all of the claims of the consolidated amended complaint. On August 3, 2016, the court granted our motion to dismiss in its entirety, denied the plaintiffs’ request to replead their allegations, and dismissed the lawsuit. The plaintiffs did not file an appeal, and the time for filing an appeal has expired.

On February 29, 2016, we filed a lawsuit against Smith & Nephew, Inc. (“Smith & Nephew”) in the United States District Court for the District of Massachusetts Eastern Division, which we amended on June 13, 2016 (the "Smith & Nephew Lawsuit"). The Smith & Nephew Lawsuit alleges that Smith & Nephew’s Visionaire® patient-specific instrumentation as well as the implants systems used in conjunction with the Visionaire instrumentation infringe nine of our patents, and it requests, among other relief, monetary damages for willful infringement, enhanced damages and a permanent injunction.

On May 27, 2016, Smith & Nephew filed an Answer and Counterclaims in response to our lawsuit, which it subsequently amended on July 22, 2016. Smith & Nephew denied that its Visionaire® patient-specific instrumentation as well as the implants systems used in conjunction with the Visionaire instrumentation infringe the patents asserted by us in the lawsuit. It also alleged two affirmative defenses: that our asserted patents are invalid and that we are barred from relief under the doctrine of laches. In addition, Smith & Nephew asserted a series of counterclaims, including counterclaims seeking declaratory judgments that Smith & Nephew’s accused products do not infringe our patents and that our patents are invalid. Smith & Nephew also alleged that ConforMIS infringes ten patents owned or exclusively licensed by Smith & Nephew: two patents that Smith & Nephew alleges are infringed by our iUni and iDuo products; three patents that Smith & Nephew alleges are infringed by our iTotal products; and five patents that Smith & Nephew licenses from Kinamed, Inc. of Camarillo, California and that it alleges are infringed by our iUni, iDuo and iTotal products. Due to Smith & Nephew’s licensing arrangement with Kinamed, Kinamed has been named as a party to the lawsuit. Smith & Nephew and Kinamed have requested, among other relief, monetary damages for willful infringement, enhanced damages and a permanent injunction. An adverse outcome of this lawsuit could have a material adverse effect on our business, financial condition or results of operations. We are presently unable to predict the outcome of the lawsuit or to reasonably estimate a range of potential losses, if any, related to the lawsuit.

On September 21, 2016 and October 20, 2016, Smith & Nephew filed petitions with the United States Patent & Trademark Office (“USPTO”) requesting Inter Partes Review of our United States Patent Nos. 9,055,953 and 9,216,025, respectively. In our litigation with Smith & Nephew, we have alleged that Smith & Nephew infringes claims of these patents. In its petition, Smith & Nephew alleges that our patents are obvious in light of certain prior art.

We expect that Smith & Nephew will file additional petitions with the USPTO requesting Inter Partes Review of some or all of the patents that we have asserted in the Smith & Nephew Litigation, and we also expect that Smith & Nephew will seek a stay of the Smith & Nephew Litigation until any requested Inter Partes Reviews are resolved. We are presently unable to predict the outcome of the two existing petitions requesting Inter Partes Review of our patents, or of any other petitions requesting Inter Partes Review that Smith & Nephew or any other party may file, including whether the USPTO will institute any of the requested Inter Partes Reviews, or, if instituted, the outcome

of any such Inter Partes Reviews. An adverse outcome of some or all of these potential Inter Partes Review proceedings could have a material adverse effect on our business, financial condition or results of operations.

ITEM 1A. RISK FACTORS

The following risk factors and other information included in this Quarterly Report on Form 10-Q should be carefully considered. The risks and uncertainties described below are not the only ones we face. 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 1 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 following risks actually occur, our business, financial condition, results of operations and future growth prospects could be materially and adversely affected.

Risks related to our financial position

We have incurred losses in the past, expect to incur losses for at least the next several years and may never achieve profitability.

We have incurred significant net operating losses in every year since our inception and expect to incur net operating losses for the next several years. Our net loss was $42 million for the nine months ended September 30, 2016 and $42 million for the nine months ended September 30, 2015. As of September 30, 2016, we had an accumulated deficit of $367.2 million. We expect to continue to incur significant product development, clinical and regulatory, sales and marketing, manufacturing and other expenses as our business continues to grow and we expand our product offerings. Additionally, our general and administrative expense will continue to increase due to the additional operational and reporting costs associated with our expanded operations and being a public company. 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. In addition, our growth may slow, for reasons described in these risk factors. Our failure to become and remain profitable would decrease the value of our company and could impair our ability to raise capital, expand our business, maintain our research and development efforts or continue our operations.

We expect to incur substantial expenditures in the foreseeable future and might require additional capital to support business growth. This capital might not be available on terms favorable to us or at all.

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.

In addition, our general and administrative expense will continue to increase due to the additional operational and reporting costs associated with our expanded operations and being a public company.

We anticipate that our principal sources of funds will be revenue generated from the sales of our products and revenues that we may generate in connection with licensing our intellectual property. In November 2014, we borrowed the first of two $10 million term loans, referred to as the SVB/Oxford Term Loan A, under a loan and security agreement with Silicon Valley Bank, or SVB, and Oxford Finance, LLC, or the 2014 Secured Loan Agreement. In September 2015, we voluntarily prepaid the SVB/Oxford Term Loan A in full and terminated our right to draw down the term loans and any security interest in favor of Oxford Finance, LLC. In December 2015, we also terminated a revolving line of credit we had from SVB.

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. 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.

We may need to engage in 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 sale of equity or convertible debt, the ownership interest of our 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 our existing common stockholders or involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt or making capital expenditures.

Risks related to our business, industry and competitive position

We have a limited operating history and may face difficulties encountered by early stage companies in rapidly evolving markets.

We began operations in 2004, introduced our first product commercially in 2007 and only introduced our best-selling product, our iTotal CR, in 2011. Accordingly, we have a limited operating history upon which to base an evaluation of our business and prospects. In assessing our prospects, you must consider the risks and difficulties frequently encountered by early stage companies in new and rapidly evolving markets, particularly companies engaged in the development and sales of medical devices. These risks include our ability to:


•	manage rapidly changing and expanding operations;


•	establish and increase awareness of our brand and strengthen customer loyalty;


•	restore and expand physician relationships after disruptions in supply or delays in delivery of our products;


•	transition from our current President and Chief Executive Officer to our new President and Chief Executive Officer;


•	grow our direct sales force and increase the number of our independent sales representatives and distributors to expand sales of our products in the United States and in targeted international markets;


•	implement and successfully execute our business and marketing strategy;


•	respond effectively to competitive pressures, responses and developments;


•	continue to develop and enhance our products and products in development;


•	obtain regulatory clearance or approval to commercialize new products and enhance our existing products;


•	expand our presence in international markets;


•	perform clinical and economic research and studies on our existing products and current and future product candidates; and


•	attract, retain and motivate qualified personnel.

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. We can also be negatively affected by general economic conditions. Because of our limited operating history, we may not have insight into trends that could emerge and negatively affect our business. As a result of these or other risks, our business strategy might not be successful.

We have derived nearly all of our revenues from sales of a limited portfolio of knee replacement products and may not be able to maintain or increase revenues from these products. A substantial portion of our revenues are derived from a small number of customers.

To date, we have derived nearly all of our revenues from sales of our knee replacement products, and we expect that sales of these products will continue to account for the majority of our revenues for at least the next several years. If we are unable to achieve and maintain significantly greater market acceptance of these products, we may be materially constrained in our ability to fund our operations and the development and commercialization of improvements and other products. Any factors that negatively impact sales or growth in sales of our current products, including the size of the addressable markets for these products, our failure to convince surgeons to

adopt our products, competitive factors and other factors described in these risk factors, could adversely affect our business, financial condition and operating results.

In addition, as part of our commercial strategy we work to significantly increases our sales in targeted markets by focusing on high-volume, influential surgeons who use our products. As a result, orders from a relatively small number of surgeons provide a significant portion of our total revenue. The loss of, or significant curtailment of orders by, one or more of our high-volume doctors, including curtailments due to reduced reimbursement rates, adoption of our competitors’ products or the timing of orders by these doctors, may adversely affect our results of operations and financial condition.

We may not be successful in the development of, obtaining regulatory clearance for, or commercialization of, additional products.

We are expanding our offerings to include an additional joint replacement product for the knee, the iTotal PS, which we launched commercially, and are developing our first hip replacement product, the iTotal Hip. We initially filed for marketing clearance of the iTotal Hip in 2015 with the FDA; however, after consultation with the FDA, we elected to withdraw the application and, on September 28, 2016, we filed a new application seeking 510(k) clearance of our iTotal Hip. However, we may not be able to successfully commercialize the iTotal PS, and we may not be able to develop or obtain regulatory approval or clearance of or successfully commercialize the iTotal Hip on a timely basis or at all. Any factors that delay the commercial launch of, including the process for obtaining regulatory clearance for, our additional products, or result in sales of our additional products increasing at a lower rate than expected, could adversely affect our business, financial condition and operation results. In addition, even if we do launch these products, there can be no assurance that these products will be accepted in the market or commercially successful or profitable.

All of the products we currently market in the United States have either received pre-market clearance under Section 510(k) of the Federal Food, Drug, and Cosmetic Act, or the FDCA, or are exempt from pre-market review. The FDA's 510(k) clearance process requires us to show that our proposed product is "substantially equivalent" to another legally marketed product that did not require premarket approval. This process is shorter and typically requires the submission of less supporting documentation than other FDA approval processes and does not always require clinical studies. To date, we have not been required to conduct clinical studies or obtain clinical data in order to obtain regulatory clearance in the United States for our products. Additionally, to date, we have not been required to complete clinical studies in connection with obtaining regulatory clearance for the sale of our products outside the United States. If we must conduct clinical studies or obtain clinical data to obtain regulatory clearance or approval for any of our products in the United States or elsewhere. The results of such studies may not be sufficient to support regulatory clearance or approval. In addition, our costs of developing and the time to develop our products would increase significantly. Moreover, even if we obtain regulatory clearance or approval to market a product, the FDA, in the United States, or a Notified Body, in the EU, has the power to require us to conduct postmarketing studies beyond those we contemplate conducting. We may need to raise additional funds to support any such clinical efforts, and if we are required to conduct such clinical efforts, our results of operations would be adversely affected.

We are in a highly competitive market and face competition from large, well-established companies as well as new market entrants.

The market for orthopedic replacement products generally, and for knee and hip implant products in particular, is intensely competitive, subject to rapid change and dominated by a small number of large companies. Our principal competitors are the major producers of prosthetic knee and hip replacement products. We also compete with numerous smaller companies, many of whom have a significant regional market presence. In addition, a number of companies are developing biologic cartilage repair solutions to address osteoarthritis of the knee that could reduce the demand for knee replacement procedures and products. Stem cell therapies and other new, emerging therapies could reduce or obviate the need for joint replacement surgery in the future.

Many of our larger competitors are either publicly traded or divisions or subsidiaries of publicly traded companies, and enjoy several competitive advantages over us, including:


•	greater financial resources, cash flow, capital markets access and other resources for product research and development, sales and marketing and litigation;


•	significantly greater name recognition;


•	established relations with, in some cases over decades, orthopedic surgeons, hospitals and other medical facilities and third-party payors;


•	established products that are more widely accepted by, a greater number of orthopedic surgeons, hospitals and other medical facilities and third-party payors;


•	more complete lines of products for knee or other joint replacements;


•	larger and more well-established distribution networks with significant international presence;


•	products supported by long-term clinical data and long-term product survivorship data;


•	greater experience in obtaining and maintaining FDA and other regulatory approvals or clearances for products and product enhancements; and


•	more expansive portfolios of intellectual property rights and greater funds available to engage in legal action.

As a result of these advantages, our competitors may be able to develop, obtain regulatory clearance or approval for and commercialize products and technologies more quickly than us, which could impair our ability to compete. If alternative treatments are, or are perceived to be, superior to our products, or if we are unable to increase market acceptance of our products, as compared to existing or competitive products, sales of our products could be negatively affected and our results of operations could suffer. Our competitors also may seek to copy our products using similar technologies for use in other joints or applications into which we have not yet expanded, which would have the effect of reducing the market potential of our current or future products. In addition, based on their favorable attributes, we expect our products to be offered at higher price points than some competitive products, and our pricing decisions may make our products less competitive.

We are deploying a new business model in an effort to disrupt a relatively mature industry. In order to become profitable, we will need to scale this business model considerably through increased sales.

Our business model, based on our iFit Image-to-Implant technology platform and our just-in-time delivery is new to the joint replacement industry. We manufacture our customized replacement implants and iJigs to order and do not maintain significant inventory of finished product. We deliver the customized replacement implants and iJigs to the hospital days in advance of the scheduled arthroplasty procedure. In order to deliver our product on a timely basis, we must execute our processes on a defined schedule with limited room for error. Our competitors generally sell from a pre-produced inventory and can sell products and satisfy demand without being as dependent on business continuity. Even minor delays or interruptions to our design, manufacturing or delivery processes could result in delays in our ability to deliver products to specification, or at all, thereby significantly impacting our reputation and our ability to make commercial sales. In order to become profitable, we will need to significantly increase sales of our existing products and successfully develop and commercially launch future products at a scale that we have not yet achieved. In order to increase our gross margins we will need, among other things, to:


•	increase sales of our products;


•	negotiate more favorable prices for the materials we use to manufacture our products;


•	negotiate more favorable prices for the manufacture of certain components of our products that are manufactured for us by third parties;


•	deploy new versions of our software that reduce the costs associated with the design of our products; and


•	expand our internal manufacturing capabilities to manufacture certain components of our products at a lower unit cost than vendors we currently use.

However, we may not be successful in achieving these objectives, and our gross margins may not increase, or could even decrease. We may not be successful in executing on our business model, in increasing our gross margins or in bringing our sales and production up to a scale that will be profitable, which would have a material adverse effect on our financial condition, results of operations and cash flows.

To be commercially successful, we must convince orthopedic surgeons that our joint replacement products are attractive alternatives to our competitors' products.

Orthopedic surgeons play a significant role in determining the course of treatment and, ultimately, the type of product that will be used to treat a patient. Acceptance of our products depends on educating orthopedic surgeons as to the distinctive characteristics, perceived clinical benefits, safety and cost-effectiveness of our products as

compared to our competitors' products. If we are not successful in convincing orthopedic surgeons of the merits of our products or educating them on the use of our products, they may not use our products and we will be unable to increase our sales or reach profitability.

We believe orthopedic surgeons will not widely adopt our products unless they determine, based on experience, clinical data and published peer-reviewed journal articles, that our products and the techniques to implant them provide benefits to patients and are attractive alternatives to our competitors' products. Surgeons may be hesitant to change their medical treatment practices for the following reasons, among others:


•	comfort and experience with competitive products;


•	perceived differences in surgical technique;


•	existing relationships with competitors, competitive sales representatives and competitive distributors;


•	lack or perceived lack of evidence supporting additional patient benefits from use of our products compared to competitive products, especially products that may claim to be "customized," "patient-specific," "personalized" or "individually-made";


•	perceived convenience of using products from a more complete line of products than we offer, including as a result of our lack of a joint revision system;


•	perceived liability risks generally associated with the use of new products and procedures, including the lack of long-term clinical data;


•	perceived risks of failure of timely delivery as a result of our "just in time" manufacturing and delivery model


•	damage to our reputation as a result of our recent voluntary recall;


•	unwillingness to wait for the implants to be delivered;


•	unwillingness to submit patients to computed tomography, or CT, scans;


•	higher cost or perceived higher cost of our products compared to competitive products; and


•	the additional time commitment that may be required for training.

If clinical,