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Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2021

OR

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

For the transition period from to

Commission file number: 001-37526

TELA Bio, Inc.

(Exact name of registrant as specified in its charter)

Delaware
(State or other jurisdiction of
incorporation or organization)

    

45-5320061

(I.R.S. Employer
Identification Number) 

1 Great Valley Parkway, Suite 24

Malvern, Pennsylvania
(Address of principal executive offices)

19355

(Zip Code) 

(484) 320-2930
(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act:

Title of each class:

Trading Symbol

Name of each exchange on which registered:

Common Stock, $0.001 par value per share

TELA

The Nasdaq Global Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer

    

Accelerated filer

Smaller reporting company  

Non-accelerated filer  

Emerging growth company

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

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

As of November 3, 2021, the registrant had 14,503,570 shares of Common Stock, $0.001 par value per share, outstanding.

Table of Contents

TABLE OF CONTENTS

PART I FINANCIAL INFORMATION

Item 1.

Financial Statements

4

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

17

Item 3.

Quantitative and Qualitative Disclosures About Market Risk

27

Item 4.

Controls and Procedures

28

PART II OTHER INFORMATION

Item 1.

Legal Proceedings

28

Item 1A.

Risk Factors

28

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

28

Item 3.

Defaults Upon Senior Securities

29

Item 4.

Mine Safety Disclosures

29

Item 5.

Other Information

29

Item 6.

Exhibits

30

Signatures

31

1

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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS

Statements made in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 (“Quarterly Report”) that are not statements of historical or current facts, such as those under the heading “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Forward-looking statements discuss our business, operations and financial performance and conditions, as well as our plans, objectives and expectations for our business operations and financial performance and condition. In some cases, you can identify forward-looking statements by terminology such as “aim,” “anticipate,” “assume,” “believe,” “contemplate,” “continue,” “could,” “design,” “due,” “estimate,” “expect,” “goal,” “intend,” “may,” “objective,” “plan,” “predict,” “positioned,” “potential,” “seek,” “should,” “target,” “will,” “would” and other similar expressions that are predictions of or indicate future events and future trends, or the negative of these terms or other comparable terminology. In addition, statements that “we believe” or similar statements reflect our beliefs and opinions on the relevant subject. These forward-looking statements, which are subject to risks, uncertainties and assumptions about us, may include projections of our future financial performance, our anticipated growth strategies and anticipated trends in our business.

You should understand that the following important factors could affect our future results and could cause those results or other outcomes to differ materially from those expressed or implied in our forward-looking statements:

the full extent of the impact on our business from the pandemic resulting from the novel coronavirus and the disease it causes and variants thereof, such as the delta variant (“COVID-19”), is highly uncertain and difficult to predict and it may continue to impact our business, results of operations and financial condition, including our revenue (resulting from deferrals of elective procedures using our products), expenses, manufacturing capability, supply chain integrity, research and development activities, and employee-related matters, including compensation;
any future developments around COVID-19 and the uncertainty of COVID-19, including new information that may emerge, changes in the rate of COVID-19 transmission and infection, the emergence of new variants of COVID-19, such as the delta variant, the availability of vaccinations for COVID-19, changes in the level of restrictions imposed by governmental authorities (and the resulting impact on the frequency of surgical procedures using our products), access to hospitals, and other actions taken to contain or treat COVID-19, as well as the economic impact on regional, national and international customers and markets;
estimates regarding future results of operations, financial position, research and development costs, capital requirements and our needs for additional financing;
the commercial success and the degree of market acceptance of our products;
our ability to expand, manage and maintain our direct sales and marketing organization and to market and sell our products in the United States;
the performance of Aroa Biosurgery Ltd. (“Aroa”), in connection with the development and production of our products;
our ability to compete successfully with larger competitors in our highly competitive industry;
our ability to achieve and maintain adequate levels of coverage or reimbursement for our current products and any future products we may seek to commercialize;
our ability to enhance our products, expand our indications and develop and commercialize additional products;
the development, regulatory approval, efficacy and commercialization of competing products;
our business model and strategic plans for our products, technologies and business, including our implementation thereof;
the size of the markets for our current and future products;
our ability to attract and retain senior management and other highly qualified personnel;
our ability to obtain additional capital to finance our planned operations;
our ability to commercialize or obtain regulatory approvals for our products, or the effect of delays in commercializing or obtaining regulatory approvals;
regulatory developments in the U.S. and internationally;
our ability to develop and maintain our corporate infrastructure, including our internal controls;

2

Table of Contents

our ability to establish and maintain intellectual property protection for our products, as well as our ability to operate our business without infringing the intellectual property rights of others;
our expectations regarding the use of proceeds from our public offerings of common stock;
the occurrence of adverse safety events, restrictions on use with our products or product liability claims; and
other risks and uncertainties, including those listed under the caption “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2020 (our “Annual Report”), our Quarterly Reports on Form 10-Q and the other documents we file with the Securities and Exchange Commission (the “SEC”).

These forward-looking statements are based on management's current expectations, estimates, forecasts and projections about our business and the industry in which we operate, and management's beliefs and assumptions are not guarantees of future performance or development and involve known and unknown risks, uncertainties and other factors that are in some cases beyond our control. In light of the significant uncertainties in these forward-looking statements, you should not rely upon forward-looking statements as predictions of future events. Although we believe the expectations reflected in the forward-looking statements are reasonable, the future results, levels of activity, performance or events and circumstances reflected in the forward-looking statements may not be achieved or occur at all. Except as required by law, we undertake no obligation to publicly update any forward-looking statements, whether as a result of new information, future events or otherwise after the date of this Quarterly Report on Form 10-Q or to reflect the occurrence of any unanticipated events. Comparisons of results for current and any prior periods are not intended to express any future trends on indications of future performance, unless expressed as such, and should only be viewed as historical data.

3

Table of Contents

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

TELA Bio, Inc.

Consolidated Balance Sheets

(In thousands, except share and per share amounts)

(Unaudited)

September 30, 

December 31, 

2021

2020

Assets

 

  

 

  

Current assets:

 

  

 

  

Cash and cash equivalents

$

53,636

$

74,394

Accounts receivable, net

 

3,573

 

2,683

Inventory

 

6,269

 

3,907

Prepaid expenses and other assets

 

2,061

 

2,241

Total current assets

 

65,539

 

83,225

Property and equipment, net

 

891

 

626

Intangible assets, net

 

2,379

 

2,607

Total assets

$

68,809

$

86,458

Liabilities and stockholders’ equity

 

  

 

  

Current liabilities:

 

  

 

  

Accounts payable

$

2,334

$

652

Accrued expenses and other current liabilities

 

7,043

 

5,953

Total current liabilities

 

9,377

 

6,605

Long‑term debt with related party

 

31,315

 

30,827

Other long‑term liabilities

 

388

 

Total liabilities

 

41,080

 

37,432

Stockholders’ equity:

 

  

 

  

Preferred stock; $0.001 par value: 10,000,000 shares authorized; no shares issued and outstanding

Common stock; $0.001 par value: 200,000,000 shares authorized; 14,503,582 and 14,437,289 shares issued and 14,503,518 and 14,437,107 shares outstanding at September 30, 2021 and December 31, 2020, respectively

 

15

 

14

Additional paid-in capital

249,067

245,736

Accumulated other comprehensive loss

 

(43)

 

(71)

Accumulated deficit

 

(221,310)

 

(196,653)

Total stockholders’ equity

 

27,729

 

49,026

Total liabilities and stockholders’ equity

$

68,809

$

86,458

See accompanying notes to unaudited interim consolidated financial statements.

4

Table of Contents

TELA Bio, Inc.

Consolidated Statements of Operations and Comprehensive Loss

(In thousands, except share and per share amounts)

(Unaudited)

Three months ended

Nine months ended

September 30, 

September 30, 

2021

    

2020

    

2021

    

2020

Revenue

$

7,654

$

5,313

$

21,089

$

12,546

Cost of revenue (excluding amortization of intangible assets)

 

2,976

 

1,950

 

7,707

 

4,746

Amortization of intangible assets

 

76

 

76

 

228

 

228

Gross profit

 

4,602

 

3,287

 

13,154

 

7,572

Operating expenses:

 

  

 

  

 

  

 

  

Sales and marketing

 

6,948

 

6,342

 

20,749

 

15,734

General and administrative

 

3,462

 

2,607

 

9,184

 

7,274

Research and development

 

1,409

 

1,201

 

5,018

 

3,092

Total operating expenses

 

11,819

 

10,150

 

34,951

 

26,100

Loss from operations

 

(7,217)

 

(6,863)

 

(21,797)

 

(18,528)

Other (expense) income:

 

  

 

  

 

  

 

  

Interest expense

 

(922)

 

(898)

 

(2,675)

 

(2,661)

Other (expense) income

 

(127)

 

58

 

(185)

 

185

Total other expense

 

(1,049)

 

(840)

 

(2,860)

 

(2,476)

Net loss

$

(8,266)

$

(7,703)

$

(24,657)

$

(21,004)

Net loss per common share, basic and diluted

$

(0.57)

$

(0.53)

$

(1.71)

$

(1.69)

Weighted average common shares outstanding, basic and diluted

 

14,485,688

 

14,421,990

 

14,461,174

 

12,431,257

Comprehensive loss:

 

  

 

  

 

  

 

  

Net loss

$

(8,266)

$

(7,703)

$

(24,657)

$

(21,004)

Foreign currency translation adjustment

 

38

 

(29)

 

28

 

2

Comprehensive loss

$

(8,228)

$

(7,732)

$

(24,629)

$

(21,002)

See accompanying notes to unaudited interim consolidated financial statements.

5

Table of Contents

TELA Bio, Inc.

Consolidated Statements of Stockholders’ Equity

Three and Nine Months Ended September 30, 2021

(In thousands, except share amounts)

(Unaudited)

    

    

    

Accumulated

    

    

Additional

other

Common stock

paidin

comprehensive

Accumulated

    

Shares

    

Amount

    

capital

    

(loss) income

    

deficit

    

Total

Balance at July 1, 2021

 

14,471,774

$

14

$

248,076

$

(81)

$

(213,044)

$

34,965

Vesting of common stock previously subject to repurchase

 

36

 

 

 

 

 

Exercise of stock options

 

31,708

 

1

 

258

 

 

 

259

Foreign currency translation adjustment

 

 

 

 

38

 

 

38

Stock‑based compensation expense

 

 

 

733

 

 

 

733

Net loss

 

 

 

 

 

(8,266)

 

(8,266)

Balance at September 30, 2021

 

14,503,518

$

15

$

249,067

$

(43)

$

(221,310)

$

27,729

    

    

    

Accumulated

    

Additional

other

Common stock

paidin

comprehensive

Accumulated

    

Shares

    

Amount

    

capital

    

loss

deficit

    

Total

Balance at January 1, 2021

 

14,437,107

$

14

$

245,736

$

(71)

$

(196,653)

$

49,026

Vesting of common stock previously subject to repurchase

 

118

 

 

 

 

Exercise of stock options

 

54,293

 

1

 

410

 

 

411

Foreign currency translation adjustment

28

28

Stock‑based compensation expense

 

12,000

 

 

2,839

 

 

2,839

Reclassification of liability-classified stock-based compensation awards

82

82

Net loss

 

 

 

 

(24,657)

 

(24,657)

Balance at September 30, 2021

 

14,503,518

$

15

$

249,067

$

(43)

$

(221,310)

$

27,729

See accompanying notes to unaudited interim consolidated financial statements.

6

Table of Contents

TELA Bio, Inc.

Consolidated Statements of Stockholders’ Equity

Three and Nine Months Ended September 30, 2020

(In thousands, except share amounts)

(Unaudited)

    

    

    

    

Accumulated

    

    

Additional

other

Common stock

paidin

comprehensive

Accumulated

    

Shares

    

Amount

    

capital

    

income

    

deficit

    

Total

Balance at July 1, 2020

14,412,690

$

14

$

244,537

$

12

$

(181,160)

$

63,403

Vesting of common stock previously subject to repurchase

 

73

 

 

 

 

 

Exercise of stock options

 

19,457

 

 

119

 

 

 

119

Foreign currency translation adjustment

 

 

 

 

(29)

 

 

(29)

Stock‑based compensation expense

 

 

 

543

 

 

 

543

Net loss

 

 

 

 

 

(7,703)

 

(7,703)

Balance at September 30, 2020

 

14,432,220

$

14

$

245,199

$

(17)

$

(188,863)

$

56,333

Accumulated

Additional

other

Common stock

paidin

comprehensive

Accumulated

    

Shares

    

Amount

    

capital

    

(loss) income

deficit

    

Total

Balance at January 1, 2020

 

11,406,221

$

11

$

198,829

$

(19)

$

(167,859)

$

30,962

Vesting of common stock previously subject to repurchase

 

236

 

 

2

 

 

 

2

Exercise of stock options

 

25,763

 

 

163

 

 

 

163

Foreign currency translation adjustment

2

2

Stock‑based compensation expense

 

 

 

1,486

 

 

 

1,486

Issuance of common stock upon follow-on offering, net of underwriting discounts, commissions and offering costs

 

3,000,000

 

3

 

44,719

 

 

 

44,722

Net loss

 

 

 

 

 

(21,004)

 

(21,004)

Balance at September 30, 2020

 

14,432,220

$

14

$

245,199

$

(17)

$

(188,863)

$

56,333

See accompanying notes to unaudited interim consolidated financial statements.

7

Table of Contents

TELA Bio, Inc.

Consolidated Statements of Cash Flows

(In thousands)

(Unaudited)

Nine months ended September 30, 

    

2021

2020

Cash flows from operating activities:

Net loss

$

(24,657)

$

(21,004)

Adjustments to reconcile net loss to net cash used in operating activities:

Depreciation expense

 

170

 

158

Noncash interest expense

 

488

 

430

Amortization of intangible assets

 

228

 

228

Inventory excess and obsolescence charge

 

1,334

 

1,221

Stock‑based compensation expense

 

2,839

 

1,486

Change in operating assets and liabilities:

Accounts receivable, net

 

(896)

 

190

Inventory

 

(3,701)

 

(664)

Prepaid expenses and other assets

 

180

 

1,440

Accounts payable

 

1,586

 

(1,675)

Accrued expenses and other current and long-term liabilities

 

1,561

 

831

Foreign currency remeasurement loss

24

7

Net cash used in operating activities

 

(20,844)

 

(17,352)

Cash flows from investing activities:

Proceeds from the sale and maturity of short-term investments

9,289

Purchase of property and equipment

 

(338)

 

(129)

Net cash (used in) provided by investing activities

 

(338)

 

9,160

Cash flows from financing activities:

Proceeds from follow-on offering, net of underwriting discounts, commissions and offering costs

44,722

Payment of initial public offering costs

(522)

Proceeds from exercise of stock options

 

411

 

163

Net cash provided by financing activities

 

411

 

44,363

Effect of exchange rate on cash and cash equivalents

 

13

 

(6)

Net (decrease) increase in cash and cash equivalents

 

(20,758)

 

36,165

Cash and cash equivalents, beginning of period

 

74,394

 

45,302

Cash and cash equivalents, end of period

$

53,636

$

81,467

Supplemental disclosure of cash flow information:

Cash paid during the period for interest

$

2,187

$

2,231

Supplemental disclosures of noncash investing and financing activities:

Property and equipment in accounts payable

$

97

$

4

Issuance of common stock for early exercised stock options

$

$

2

Reclassification of liability-classified stock-based compensation awards to equity-classified

$

82

$

See accompanying notes to unaudited interim consolidated financial statements.

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements

(1) Background

TELA Bio, Inc. (the “Company”) was incorporated in the state of Delaware on April 17, 2012 and wholly owns TELA Bio Limited, a company incorporated in the United Kingdom. The Company is focused on the commercialization and sale of OviTex Reinforced Tissue Matrix (“OviTex”), which utilizes surgical reconstruction medical device technology licensed from a strategic partner, Aroa Biosurgery Ltd. (“Aroa”) and on the research and development of additional medical devices with Aroa and on other internally developed technologies. In April 2019, the Company received 510(k) clearance from the U.S. Food and Drug Administration (“FDA”) for OviTex PRS Reinforced Tissue Matrix (“OviTex PRS”), which addresses unmet needs in plastic and reconstructive surgery. The Company’s principal corporate office and research facility is located in Malvern, Pennsylvania.

(2) Risks and Liquidity

The Company’s operations to date have focused on commercializing products, developing and acquiring technology and assets, business planning, raising capital and organization and staffing. The Company has incurred recurring losses and negative cash flows from operations since inception and has an accumulated deficit of $221.3 million as of September 30, 2021. The Company anticipates incurring additional losses until such time, if ever, it can generate sufficient revenue from its products to cover its expenses.

The operations of the Company are subject to certain risks and uncertainties including, among others, the uncertainty of product development, the impact of COVID-19 and the development of variants of COVID-19, including the delta variant, on the business, ongoing economic uncertainty, technological uncertainty, commercial acceptance of any developed products, alternative competing technologies, dependence on collaborative partners, uncertainty regarding patents and proprietary rights, comprehensive government regulations, and dependence on key personnel.

(3) Summary of Significant Accounting Policies

The Company’s complete summary of significant accounting policies can be found in “Note 3, Summary of Significant Accounting Policies” in the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2020. Any reference in these notes to applicable guidance is meant to refer to generally accepted accounting principles (“GAAP”) in the United States as found in the Accounting Standards Codification (“ASC”) and Accounting Standards Updates (“ASU”) promulgated by the Financial Accounting Standards Board (“FASB”).

Interim Financial Statements

The accompanying unaudited interim consolidated financial statements have been prepared from the books and records of the Company in accordance with GAAP for interim financial information and Rule 10-01 of Regulation S-X promulgated by the SEC, which permits reduced disclosures for interim periods. All adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the accompanying consolidated balance sheets and statements of operations and comprehensive loss, stockholders’ equity and cash flows have been made. Although these interim consolidated financial statements do not include all of the information and footnotes required for complete annual consolidated financial statements, management believes the disclosures are adequate to make the information presented not misleading. Unaudited interim results of operations and cash flows are not necessarily indicative of the results that may be expected for the full year. Unaudited interim consolidated financial statements and footnotes should be read in conjunction with the consolidated financial statements and footnotes included in the Annual Report on Form 10-K for the year ended December 31, 2020.

Use of Estimates

The preparation of consolidated financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements (Continued)

contingent liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. The most significant judgments are employed in estimates used to determine the fair value of stock-based awards issued and recoverability of the carrying value of the Company’s inventory. As future events and their effects cannot be determined with precision, actual results may differ significantly from these estimates.

The full extent to which the COVID-19 pandemic will directly or indirectly impact the Company’s business, results of operations and financial condition, including revenue, expenses, manufacturing capability, supply chain integrity, research and development costs and employee-related compensation, will depend on future developments that are highly uncertain, including new information that may emerge concerning COVID-19 and the actions taken to mitigate the spread of or to treat COVID-19, the emergence of new variants of COVID-19, such as the delta variant, as well as the economic impact on local, regional, national and international customers and markets.

Revenue Recognition

Under ASC Topic 606, Revenue from Contracts with Customers, an entity recognizes revenue when its customer obtains control of the promised good, in an amount that reflects the consideration that the entity expects to be entitled in exchange for those goods. The Company performs the following five steps to recognize revenue under ASC Topic 606: (i) identify the contract(s) with a customer, (ii) identify the performance obligations in the contract, (iii) determine the transaction price, (iv) allocate the transaction price to the performance obligations in the contract, and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company only recognizes revenue when it is probable that it will collect the consideration to which it is entitled in exchange for the goods or services that will be transferred to the customer.

A significant portion of the Company’s revenue is generated from product shipped to a customer or from consigned inventory maintained at hospitals. Revenue from the sale of consigned products is recognized when control is transferred to the customer, which occurs at the time the product is used in a surgical procedure. For product that is not held on consignment, the Company recognizes revenue when control transfers to the customer which occurs at the time the product is shipped or delivered. For all of the Company’s contracts, the only identified performance obligation is providing the product to the customer.

Revenue is recognized at the estimated net sales price which includes estimates of variable consideration. The Company contracts with certain third-party payors for the payment of rebates with respect to the utilization of its products. These rebates are based on contractual percentages. The Company estimates these rebates and records in the same period the related revenue is recognized, resulting in a reduction of product revenue.

Payment terms with customers do not exceed one year and, therefore, the Company does not account for a financing component in its arrangements. There are no incremental costs of obtaining a contract that would rise to or enhance an asset other than product costs, which are a component of inventory. The Company expenses incremental costs of obtaining a contract with a customer (e.g., sales commissions) when incurred as the period of benefit is less than one year. Fees charged to customers for shipping are recognized as revenue.

The following table presents revenue disaggregated by our portfolio of products (in thousands):

Three months ended September 30, 

Nine months ended September 30, 

2021

2020

2021

2020

OviTex

$

6,072

$

4,526

$

16,500

$

10,707

OviTex PRS

1,582

787

4,589

1,839

Total revenue

$

7,654

$

5,313

$

21,089

$

12,546

Sales outside of the United States were immaterial for the three and nine months ended September 30, 2021 and 2020.

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements (Continued)

Fair value of financial instruments

Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction among market participants. Fair value determination in accordance with applicable accounting guidance requires that a number of significant judgments are made. Additionally, fair value is used on a nonrecurring basis to evaluate assets for impairment or as required for disclosure purposes by applicable accounting guidance on disclosures about fair value of financial instruments. Depending on the nature of the assets and liabilities, various valuation techniques and assumptions are used when estimating fair value. The carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable and other assets, and accounts payable are shown at cost, which approximates fair value due to the short-term nature of these instruments. Due to the related-party relationship of the credit facility (the “OrbiMed Credit Facility”) with OrbiMed Royalty Opportunities IP, LP (“OrbiMed”) (Note 5), it is impractical to determine the fair value of the debt.

The Company follows the provisions of FASB ASC Topic 820, Fair Value Measurement, for financial assets and liabilities measured on a recurring basis. The guidance requires fair value measurements be classified and disclosed in one of the following three categories:

Level 1: Unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2: Quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liabilities.
Level 3: Prices or valuation techniques that require inputs that are both significant to the fair value measurement and unobservable (i.e., supported by little or no market activity).

The following fair value hierarchy table presents information about each major category of the Company’s financial assets and liabilities measured at fair value on a recurring basis (in thousands):

Fair value measurement at reporting date using

Quoted prices in

active markets

Significant other

Significant

for identical

observable

unobservable

assets

inputs

inputs

    

(Level 1)

    

(Level 2)

    

(Level 3)

September 30, 2021:

Cash equivalents – money market fund

$

50,395

$

$

December 31, 2020:

Cash equivalents – money market fund

$

72,889

$

$

Net loss per common share

Basic and diluted net loss per common share is determined by dividing net loss by the weighted-average shares of common stock outstanding during the reporting period. A net loss cannot be diluted, so when the Company is in a net loss position, basic and diluted loss per common share are the same.

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements (Continued)

The following potentially dilutive securities have been excluded from the computation of diluted weighted-average shares outstanding for the periods presented, as they would be antidilutive.

Three and nine months ended September 30,

2021

2020

Stock options (including shares subject to repurchase)

1,708,601

 

1,495,642

Unvested restricted stock units

163,978

Common stock warrants

88,556

88,556

Total

 

1,961,135

 

1,584,198

Recently Issued Accounting Pronouncements

The Company is an emerging growth company, as defined in the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act, until such time as those standards apply to private companies. The Company has elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that it (i) is no longer an emerging growth company or (ii) affirmatively and irrevocably opts out of the extended transition period provided in the JOBS Act. As a result, these consolidated financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates.

In February 2016, the FASB issued ASU No. 2016-02, Leases, which requires a lessee to record a right-of-use asset and a corresponding lease liability on the balance sheet for all leases with terms longer than 12 months. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. An entity may choose to use either (1) its effective date or (2) the beginning of the earliest comparative period presented in the consolidated financial statements as its date of initial application. If an entity chooses the second option, the transition requirements for existing leases also apply to leases entered into between the date of initial application and the effective date. The standard is effective for the Company beginning January 1, 2022, with early adoption permitted. The Company plans to adopt this standard on January 1, 2022 and is currently evaluating the expected impact that the standard will have on its consolidated financial statements and related disclosures.

In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes. This guidance applies to all entities and aims to reduce the complexity of tax accounting standards while enhancing reporting disclosures. This guidance is effective for fiscal years beginning after December 15, 2020 and interim periods therein. Early adoption is permitted for any annual periods for which financial statements have not been issued and interim periods therein. The adoption of this guidance did not have any impact on the Company’s consolidated financial statements and related disclosures.

(4) Accrued Expenses and Other Current Liabilities

Accrued expenses and other current liabilities consisted of the following (in thousands):

September 30, 

December 31, 

    

2021

    

2020

Compensation and related benefits

$

4,026

$

3,666

Interest

 

 

40

Third-party and professional fees

 

1,993

 

1,626

Amounts due to Aroa

780

498

Research and development expenses

48

7

Other

 

196

 

116

Total accrued expenses and other current liabilities

$

7,043

$

5,953

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements (Continued)

(5) Long-term Debt

Long-term debt consisted of the following (in thousands):

September 30, 

December 31, 

    

2021

    

2020

OrbiMed Term Loan (related party)

$

30,000

$

30,000

End of term charge

 

3,000

 

3,000

Unamortized end of term charge and issuance costs

 

(1,685)

 

(2,173)

Long-term debt with related party

$

31,315

$

30,827

OrbiMed Term Loan (Related Party)

In November 2018, the Company entered into the OrbiMed Credit Facility with OrbiMed, a related party as the lender is affiliated with a stockholder of the Company, which consists of up to $35.0 million in term loans (the “OrbiMed Term Loans”). The OrbiMed Term Loans consist of two tranches, a $30.0 million Tranche 1 (“Tranche 1”) and a $5.0 million Tranche 2 (“Tranche 2”). In November 2018, the Company borrowed $30.0 million of Tranche 1. The Company elected not to borrow Tranche 2 prior to its expiration on December 31, 2019.

Pursuant to the OrbiMed Credit Facility, the Company provided a first priority security interest in all existing and future acquired assets, excluding intellectual property and certain other assets, owned by the Company. The OrbiMed Credit Facility contains a negative pledge on intellectual property owned by the Company. The OrbiMed Credit Facility also contains customary indemnification obligations and customary events of default, including, among other things, (i) nonpayment, (ii) breach of warranty, (iii) nonperformance of covenants and obligations, (iv) default on other indebtedness, (v) judgments, (iv) change of control, (vii) bankruptcy and insolvency, (viii) impairment of security, (ix) key permit events, (x) key person events, (xi) regulatory matters, (xii) and key contracts. In addition, the Company must maintain a minimum cash balance of $2.0 million. If an event of default occurs under the OrbiMed Credit Facility, the Company may become obligated to immediately pay all outstanding principal and interest and all other due and unpaid obligations at the current rate in effect plus 3%.

The OrbiMed Term Loan matures on November 16, 2023 and bears interest at a rate equal to 7.75% plus the greater of one-month LIBOR or 2.0%. At September 30, 2021, the interest rate was 9.75%. The Company is required to make 60 monthly interest payments beginning on November 30, 2018, with the entire principal payment due at maturity. The OrbiMed Term Loans have a prepayment penalty equal to 10.0% of the prepaid principal amount prior to the second anniversary of the Term Loans, 5.0% of the prepaid principal amount after the second anniversary but prior to the third anniversary and 2.5% of the prepaid principal amount after the third anniversary. The Company is also required to pay an exit fee at the time of maturity or prepayment event equal to 10.0% of all principal borrowings (the “End of Term Charge”) and an administration fee equal to $10,000 on the last day of each quarter until all obligations have been paid in full. In conjunction with the closing of the OrbiMed Term Loans, the Company incurred $0.3 million of third-party and lender fees, which along with the End of Term charge of $3.0 million were recorded as debt issuance costs, and are being recognized as interest expense over the term of the loan using the effective-interest method. Interest expense associated with the OrbiMed Credit Facility recorded for the nine months ended September 30, 2021, was $2.7 million, of which $0.5 million was related to the amortization of debt issuance costs. Interest expense associated with the OrbiMed Credit Facility recorded for the nine months ended September 30, 2020, was $2.7 million, of which $0.4 million was related to the amortization of debt issuance costs.

(6) Stockholders’ Equity

In December 2020, the Company entered into an Equity Distribution Agreement (the “Equity Agreement”) with Piper Sandler & Co (the “Agent”) in connection with the establishment of an at-the-market offering program under which it may sell up to an aggregate of $50.0 million of shares of the Company’s common stock, from time to time through the

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements (Continued)

Agent as sales agent. No sales were made under the Equity Agreement during the nine months ended September 30, 2021.

Warrants

The Company had the following warrants outstanding to purchase common stock at September 30, 2021:

Exercise

Expiration

    

Outstanding

    

price

    

dates

Common stock warrants issued to MidCap

 

8,379

$

28.65

 

2028

Common stock warrants issued to note payable holders

 

15,712

 

28.65

 

2027

Common stock warrants issued to convertible promissory note holders

 

64,465

$

28.65

 

2027

 

88,556

(7) Stock-Based Compensation

The Company has two equity incentive plans: the 2012 Stock Incentive Plan and the Amended and Restated 2019 Equity Incentive Plan. New awards can only be granted under the Amended and Restated 2019 Equity Incentive Plan (the “Plan”). At September 30, 2021, 886,606 shares of common stock were available for future issuances under the Plan. The Plan is subject to an annual increase, subject to prior approval by the Company’s board of directors, equal to the lesser of (i) 432,442 shares, (ii) 4% of the shares outstanding on the last day of the immediately preceding fiscal year and (iii) such smaller number of shares as determined by the board of directors. The Plan provides for the grant of incentive stock options, nonqualified stock options, restricted stock awards, restricted stock units and/or stock appreciation rights to employees, directors, and other persons, as determined by the Company’s board of directors. The Company estimates forfeitures that it expects will occur and adjusts expense for actual forfeitures in the periods they occur.

The Company measures employee and nonemployee stock-based awards at grant-date fair value and records compensation expense ratably over the vesting period of the award. The Company recorded stock-based compensation expense in the following expense categories of the accompanying consolidated statements of operations and comprehensive loss (in thousands):

Three months ended September 30, 

    

Nine months ended September 30, 

    

2021

    

2020

    

2021

2020

Sales and marketing

$

257

$

179

$

694

$

512

General and administrative

359

 

279

 

1,110

 

728

Research and development

 

117

 

85

 

1,035

 

246

Total stock‑based compensation

$

733

$

543

$

2,839

$

1,486

Stock Options

The Company’s stock options vest based on the terms in each award agreement and generally vest over four years and have a term of 10 years.

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements (Continued)

The following table summarizes stock option activity for the Plan:

Weighted

average

Weighted

remaining

Number of

average exercise

contractual term

    

shares

    

price per share

    

(years)

Outstanding at January 1, 2021

1,498,208

10.87

Granted

440,600

14.96

Exercised

(54,293)

7.55

Canceled/forfeited

(175,978)

13.05

Outstanding at September 30, 2021

1,708,537

$

11.81

7.48

Vested and expected to vest at September 30, 2021

 

1,652,079

$

11.74

 

7.43

Exercisable at September 30, 2021

 

883,728

$

10.00

 

6.18

At September 30, 2021, the aggregate intrinsic value of outstanding options and exercisable options was $4.1 million and $3.5 million, respectively.

The 2012 Stock Incentive Plan provided the holders of stock options an election to early exercise prior to vesting. The Company has the right, but not the obligation, to repurchase early exercised options without transferring any appreciation to the employee if the employee terminates employment before the end of the original vesting period. The repurchase price is the lesser of the original exercise price or the then fair value of the common stock. At September 30, 2021, an immaterial amount of proceeds from early exercised options were recognized as a current liability in other current liabilities in the accompanying consolidated balance sheet.

The following table summarizes activity relating to early exercise of stock options:

Number of

    

shares

Unvested balance at January 1, 2021

182

Vested

(118)

Unvested balance at September 30, 2021

 

64

The weighted average grant-date fair value per share of options granted was $8.74 during the nine months ended September 30, 2021. The aggregate intrinsic value of options exercised was $0.2 million and $0.3 million for the three and nine months ended September 30, 2021, respectively. At September 30, 2021, the total unrecognized compensation expense related to unvested employee and nonemployee stock option awards was $5.5 million, which is expected to be recognized in expense over a weighted-average period of approximately 2.6 years.

Estimating Fair Value of Stock Options

The fair value of each grant of stock options was determined by the Company using the methods and assumptions discussed below. Certain of these inputs are subjective and generally require judgment to determine.

Expected term – The expected term of stock options represents the weighted-average period the stock options are expected to be outstanding. The Company uses the simplified method for estimating the expected term as provided by the Securities and Exchange Commission. The simplified method calculates the expected term as the average time to vesting and the contractual life of the options.

Expected volatility – Due to the Company’s limited operating history and lack of sufficient company-specific historical or implied volatility, the expected volatility assumption was determined by examining the historical volatilities of a group of industry peers whose share prices are publicly available.

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TELA Bio, Inc.

Notes to Unaudited Interim Consolidated Financial Statements (Continued)

Risk-free interest rate – The risk-free rate assumption is based on U.S. Treasury instruments, the terms of which were consistent with the expected term of the Company’s stock options.

Expected dividend – The Company has not paid and does not intend to pay dividends.

The fair value of each option was estimated on the date of grant using the Black-Scholes option pricing model and the weighted average assumptions in the table below:

Nine months ended

    

September 30, 2021

 

Expected dividend yield

 

Expected volatility

 

63.8

%

Risk‑free interest rate

 

0.97

%

Expected term (in years)

 

6.15

Restricted Stock Units

The Company’s restricted stock units (“RSUs”) vest based on the terms in each award agreement and generally vest over four years. The following table summarizes restricted stock units for the Plan:

Number of

    

shares

Outstanding at January 1, 2021

Granted

194,232

Vested

(12,000)

Canceled/forfeited

(18,254)

Outstanding at September 30, 2021

163,978

The weighted average grant-date fair value per RSU granted was $16.57 during the nine months ended September 30, 2021. The aggregate intrinsic value of RSUs outstanding was $2.2 million at September 30, 2021. The total unrecognized compensation expense at September 30, 2021 related to RSUs was $1.8 million, which is expected to be recognized in expense over a weighted-average period of approximately 3.4 years.

(8) Related-Party Transactions

On November 16, 2018, the Company entered into a senior secured term loan facility with OrbiMed, an entity affiliated with an owner of a material amount of the Company’s outstanding voting securities. The terms of the debt and related components are described in more detail in Note 5.

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Item 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following Management’s Discussion and Analysis of Financial Condition and Results of Operations, as well as other sections in this Quarterly Report on Form 10-Q for the quarter ended September 30, 2021 (the “Quarterly Report”), should be read in conjunction with our unaudited interim consolidated financial statements and related notes thereto included elsewhere herein and the consolidated financial statements and notes thereto for the year ended December 31, 2020 and the related Management’s Discussion and Analysis of Financial Condition and Results of Operation, both of which are contained in our Annual Report on Form 10-K for the year ended December 31, 2020 (the “Annual Report”) filed with the Securities and Exchange Commission (“SEC”) on March 25, 2021. In addition to historical financial information, some of the information contained in the following discussion and analysis contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts, including statements regarding our future results of operations and financial position, business strategy, current and prospective products, product approvals, research and development costs, current and prospective collaborations, timing and likelihood of success, plans and objectives of management for future operations and future results of current and anticipated products, are forward-looking statements. These statements involve known and unknown risks, uncertainties, assumptions 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.

Overview

We are a commercial-stage medical technology company focused on designing, developing and marketing innovative tissue reinforcement materials to address unmet needs in soft tissue reconstruction. We are committed to providing patients with advanced, economically effective biologic material repair solutions to minimize long-term exposure to permanent synthetic materials and improve clinical outcomes. Our products are purposefully designed to address the shortcomings of existing reinforcement materials in hernia repair, abdominal wall reconstruction and plastic and reconstructive surgery.

Our first portfolio of products, the OviTex Reinforced Tissue Matrix (“OviTex”), addresses unmet needs in hernia repair and abdominal wall reconstruction by combining the benefits of biologic matrices and polymer materials while minimizing their shortcomings, at a cost-effective price. Our OviTex products have received 510(k) clearance from the U.S. Food and Drug Administration (“FDA”), which clearance was obtained and is currently held by Aroa Biosurgery Ltd. (“Aroa”), our exclusive manufacturer and supplier. Interim results of our ongoing prospective, single arm, multicenter post-market clinical study, which we refer to as our BRAVO study, were recently published in the Journal of Clinical Medicine. The interim analysis of patients reaching 12-month follow-up suggests that OviTex is safe and clinically effective for treatment of ventral hernias. The recurrence rate is 2.7% at 12 months. Twenty-four month follow-up has been completed for all possible patients, and recurrence rate remains below 5%. Final analysis is underway and full results will be presented in a future peer-reviewed publication. Our second portfolio of products, the OviTex PRS Reinforced Tissue Matrix (“OviTex PRS”), addresses unmet needs in plastic and reconstructive surgery. In April 2019, our OviTex PRS products received 510(k) clearance from the FDA, which clearance was obtained by Aroa and is currently held by us.

We began commercialization of our OviTex products in the United States in July 2016 and they are now used by more than 380 hospital accounts. Our OviTex portfolio consists of multiple products for hernia repair and abdominal wall reconstruction, inguinal hernia repair and hiatal hernia repair. In addition, to address the significant increase in the number of robotic-assisted hernia repairs over the last several years, we have designed an OviTex product line for use in laparoscopic and robotic-assisted surgery (“OviTex LPR”), which we began commercializing in November 2018. We subsequently expanded the OviTex LPR product line in December 2019.

OviTex PRS is indicated for use in implantation to reinforce soft tissue where weakness exists in patients requiring soft tissue repair or reinforcement in plastic and reconstructive surgery. We commenced a limited launch in May 2019 and have gathered clinical feedback from our initial surgeon users. Based on this feedback, we expanded our commercial

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launch in June 2020 and expect to continue to expand our surgeon network. We also intend to engage in discussions with the FDA regarding an Investigational Device Exemption protocol to study the safety and effectiveness of our OviTex PRS product for an indication in breast reconstruction surgery. The FDA has stated that a premarket approval, rather than a 510(k) clearance, will be required for such an indication.

We market our products through a single direct sales force, predominantly in the United States augmented by distributors in certain European countries. We have invested in our direct sales and marketing infrastructure in order to expand our presence and to promote awareness and adoption of our products. As of September 30, 2021, we had 45 sales territories in the United States. As part of our commercial strategy, we plan to continue to invest in our commercial organization by hiring additional account managers, clinical development specialists and administrative support staff to support and service new accounts for soft tissue reconstruction procedures. Additionally, we believe we can enhance the productivity of our sales force by improving customer segmentation and targeting, leveraging digital channels to engage customers and utilizing engagement analytics to support development.

We are currently devoting research and development resources to develop additional versions of our OviTex hernia product lines, including self-adhering technology to further enhance product compatibility in robotic procedures, as well as additional versions of our OviTex PRS product lines. We are also working to develop new product features and designs for both our existing OviTex and OviTex PRS products. Additionally, we are exploring new packaging technology to increase the shelf life of our OviTex and OviTex PRS products. We intend to continue to make investments in research and development efforts to develop improvements and enhancements. We are also assessing strategic partnerships with medical device companies whereby we may enter into distribution, product development and/or licensing agreements for products complimentary to, or related to, existing and future products in our distribution channel, which could result in the payment of low single digit royalties or other product acquisition costs.

Our products are manufactured by Aroa at their FDA registered and ISO 13485 compliant facility in Auckland, New Zealand. We maintain our Aroa License for the exclusive supply of ovine rumen and manufacture of our reinforced tissue matrices under which we purchase product from Aroa at a fixed cost equal to 27% of our net sales of licensed products. This revenue sharing arrangement allows us to competitively price our products and pass along cost savings to our customers.

Substantially all our revenue to date has been generated by the sale of our OviTex products. Our revenue increased by $2.3 million, or 44%, from $5.3 million for the three months ended September 30, 2020 to $7.7 million for the three months ended September 30, 2021, and by $8.5 million, or 68%, from $12.5 million for the nine months ended September 30, 2020 to $21.1 million for the nine months ended September 30, 2021. Our net loss increased by $0.6 million, or 7%, from $7.7 million for the three months ended September 30, 2020 to $8.3 million for the three months ended September 30, 2021, and by $3.7 million, or 17%, from $21.0 million for the nine months ended September 30, 2020 to $24.7 million for the nine months ended September 30, 2021. We have not been profitable since inception and as of September 30, 2021, we had an accumulated deficit of $221.3 million. We expect to incur losses for the foreseeable future.

Business Update Regarding COVID-19

Our business has been impacted by the COVID-19 pandemic and the development of variants of COVID-19, including the delta variant. We continue to closely monitor developments related to the COVID-19 pandemic and our decisions will continue to be driven by the health and well-being of our employees, hospital and physician customers, and their patients while maintaining operations to support our customers and their patients in the near-term. These developments include:

Surgery Deferrals: We believe our revenue was slightly impacted during the first quarter of 2021, mostly in January 2021, due to COVID-19 resurgences and lower surgical procedural volumes, though not the levels seen in early 2020. This impact subsided throughout the remaining months of the first quarter and the second quarter of 2021, however, we believe our revenue in the third quarter of 2021 was also impacted due to the surge of new COVID-19 cases relating to new variants, such as the delta variant, primarily in September. The extent of future elective surgery deferrals and the timing and extent of the economic impact of the pandemic, and the

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pace at which the economy recovers therefrom, cannot be determined at this time, particularly in light of recent surges and the continued emergence of new variants. We continue to work closely with our hospital and physician customers and suppliers to navigate through this unforeseen event while maintaining flexible operations. The reallocation of hospital resources to treat COVID-19 may continue to cause a financial strain on healthcare systems and reduce procedural volumes.
Operations: Our sales, marketing and research and development efforts have continued since the outbreak of the pandemic. As the hospital access environment continues to evolve throughout this pandemic and practices vary from hospital to hospital and state to state, our sales team has continued to adapt to changing conditions within their regions. Most of our sales professionals have used a virtual selling program, which includes virtual sales calls with physicians, peer-to-peer discussions with key opinion leaders, physician webinars and sales professional training to supplement our in-person sales and marketing programs. We expect to continue to adapt our sales and marketing plans as we continue to gain better visibility into the effects of the COVID-19 pandemic on our business. As Aroa is located and headquartered in Auckland, New Zealand, where COVID-19 mitigation efforts have to date been effective, our manufacturing and supply chain has largely been uninterrupted. However, it could be disrupted in the future because of the pandemic due to staffing shortages, production slowdowns, stoppages, travel and shipping restrictions or disruptions in delivery systems.
Product Development: We continue to evaluate the timing and scope of planned next generation product development and commercialization initiatives in light of the COVID-19 pandemic, and we plan to continue to prioritize and invest in our critical R&D and clinical programs.

2021 Results. During January, we experienced increased volatility in demand for our products as COVID-19 cases and hospitalizations increased. We saw improvement in our business during the second half of the first quarter and during the second quarter, however, we believe our revenue in the third quarter was also impacted due to the surge of new COVID-19 cases relating to new variants, such as the delta variant, primarily in September. The timing, extent and continuation of any increase in procedures, any corresponding increase in sales of our products, and whether there could be a future decrease in the current level of procedures being performed, remain uncertain and are subject to a variety of factors, including:
oA material increase in COVID-19 cases in one or more locations, including as a result of the development of new variants of COVID-19, such as the delta variant, may result in an increase in hospitalizations and a corresponding decrease in elective procedures in such impacted locations.
oThe availability and perceived safety of COVID-19 vaccines, the speed of COVID-19 vaccine distribution and administration, the timing and extent to which the vaccination process will affect the progression of the virus, and the efficacy of such vaccines against the new variants of the virus, such as the delta variant.
oGovernment vaccine mandates could affect our ability to retain or hire employees.
oGovernment restrictions on elective procedures may change over time and may vary in different geographic locations due to localized increases or decreases in the number of COVID-19 cases.
oPatients electing to defer or avoid treatment for elective procedures due to concerns about being exposed to COVID-19, loss of employer-sponsored health insurance related to unemployment in the United States or other reasons.
oHospitals may reserve increased space, personal protective equipment and staff for potential COVID-19 patients, especially if the number of COVID-19 cases in a particular region spikes or a new variant of COVID-19, such as the delta variant, emerges in such region, limiting the space and resources allocated to inpatient and outpatient elective procedures.

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oHospitals may experience staffing shortages as a result of employee non-compliance with government or employer mandated vaccination requirements, which could reduce the number of elective procedures that can be performed at hospitals with staffing shortages.
oHospitals may continue to preserve cash and may not immediately replenish their inventories of our products, which would impact our future sales and revenue and make it difficult to accurately predict our inventory requirements.

We continue to closely monitor local, regional and global COVID-19 surges as well as new variants of the virus for an impact on procedures during the fourth quarter and beyond.

Outlook. There remains uncertainty and lack of visibility regarding our near-term revenue growth prospects and product development plans due to the rapidly evolving environment and continued uncertainties resulting from the COVID-19 pandemic. At this time, the full extent of the impact of the COVID-19 pandemic on our business, financial condition and results of operations is uncertain and cannot be predicted with reasonable accuracy and will depend on future developments that are also uncertain, such as the potential development of new variants of COVID-19, and the future geographic scope of COVID-19.

Components of Our Results of Operations

Revenue

Substantially all of our revenue consists of direct sales of our products to hospital accounts in the U.S. Depending on the terms of our agreements with our customers, we recognize revenue related to product sales either when control transfers, which generally occurs when the product is shipped to the customer, or when the product is utilized in a surgical procedure in the case of consignment agreements. Fees charged to customers for shipping are recognized as revenue. Recent revenue growth has been driven by increasing revenue from product sales due to our expanding customer base, although it is unclear at this point what long-term effect the COVID-19 pandemic will have on our ability to continue to generate revenue and expand our customer base.

Cost of Revenue

Cost of revenue primarily consists of the costs of licensed products, charges related to excess and obsolete inventory adjustments and costs related to shipping. We purchase product from Aroa at a fixed cost equal to 27% of our net sales of licensed products. The initial term of our Aroa License terminates on the later of (i) August 3, 2022, or (ii) the expiration of the last patent covering bovine and ovine products, with an option to extend for an additional ten-year period. We expect our cost of revenue to increase in absolute dollars as, and to the extent, our sales volume grows, although it is unclear at this point what long-term effect, if any, the COVID-19 pandemic will have on product demand which could lead to additional charges to excess and obsolete inventory.

Amortization of Intangible Assets

Amortization of intangible assets relates to the amortization of capitalized milestone amounts paid or probable to be paid to Aroa related to license fees or commercialization rights after future economic benefit has been established for a product. These capitalized milestone amounts relate to regulatory clearances, the receipt of certain supply quantities of product, and amounts based upon aggregate net sales thresholds within a specified territory and are amortized over the remaining useful life of the intellectual property.

Gross Profit and Gross Margin

Our gross profit is calculated by subtracting our cost of revenue and amortization of intangible assets from our revenue. We calculate our gross margin percentage as our gross profit divided by our revenue. Our gross profit has been, and we expect it will continue to be, affected by a variety of factors, including sales volume, current and potential royalties and excess and inventory obsolescence costs. Our gross profit may increase to the extent our revenue grows.

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Sales and Marketing Expenses

Sales and marketing expenses consist of market research and commercial activities related to the sale of OviTex and OviTex PRS, salaries and related benefits, sales commissions and stock-based compensation for employees focused on these efforts. Other significant sales and marketing expenses include costs incurred with post-market clinical studies, conferences and trade shows, promotional and marketing activities, as well as travel and training expenses.

Over time we expect our sales and marketing expenses to increase in absolute dollars as we continue to expand our commercial organization to both drive and support our planned growth in revenue. It is unclear at this point, however, what long-term effect, if any, the COVID-19 pandemic will have on these expansion plans. We expect our sales and marketing expenses to decrease as a percentage of revenue primarily as, and to the extent, our revenue grows.

General and Administrative Expenses

General and administrative expenses consist primarily of salaries and related benefits, including stock-based compensation for personnel in executive, finance, information technology and administrative functions. General and administrative expenses also include professional service fees for legal, accounting, consulting, investor and public relations, insurance costs and direct and allocated facility-related costs.

We expect that our general and administrative expenses will increase in absolute dollars as we execute our growth initiatives and expand our business and headcount to support these initiatives. It is unclear at this point, however, what long-term effect, if any, the COVID-19 pandemic will have on these expansion plans. We expect our general and administrative expenses to decrease as a percentage of revenue primarily as, and to the extent, our revenue grows.

Research and Development Expenses

Research and development expenses consist primarily of product research, engineering, product development, regulatory compliance and clinical development. These expenses include salaries and related benefits, stock-based compensation, consulting services, costs associated with our preclinical studies, costs incurred with our manufacturing partner under development agreements related to technology transfer, laboratory materials and supplies and an allocation of related facilities costs. We expense research and development costs as they are incurred.

We expect that our research and development expenses in absolute dollars will increase in the future as we develop new products and enhance existing products although it is unclear at this point what long-term effect, if any, the COVID-19 pandemic will have on these development plans. We expect research and development expenses as a percentage of revenue to vary over time depending on the level and timing of new product development initiatives.

Interest Expense

Interest expense consists of cash interest under our credit facilities, non-cash interest attributable to the amortization of final payment fees and the amortization of deferred financing costs related to our indebtedness.

Other (Expense) Income

Other (expense) income consists primarily of miscellaneous tax expenses and foreign currency exchange gains and losses offset by income earned on our cash and cash equivalents.

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Results of Operations

Comparison of the Three Months Ended September 30, 2021 and 2020

Three Months Ended September 30, 

Change

 

    

2021

    

2020

Dollar

    

Percentage

 

(in thousands, except percentages)

 

Revenue

$

7,654

$

5,313

$

2,341

 

44

%

Cost of revenue (excluding amortization of intangible assets)  

 

2,976

 

1,950

 

1,026

 

53

Amortization of intangible assets

 

76

 

76

 

 

Gross profit

 

4,602

 

3,287

 

1,315

 

40

Gross margin

 

60

%

 

62

%

 

  

Operating expenses:

 

 

  

 

  

 

  

Sales and marketing

 

6,948

 

6,342

 

606

 

10

General and administrative

 

3,462

 

2,607

 

855

 

33

Research and development

 

1,409

 

1,201

 

208

 

17

Total operating expenses

 

11,819

 

10,150

 

1,669

 

16

Loss from operations

 

(7,217)

 

(6,863)

 

(354)

 

5

Other (expense) income:

 

 

  

 

  

 

Interest expense

 

(922)

 

(898)

 

(24)

 

3

Other (expense) income

 

(127)

 

58

 

(185)

 

(319)

Total other expense