NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1. Nature of Operations

Overview

Fuse Medical, Inc., a Delaware corporation (the “Company”), is a manufacturer and national distributor of medical devices and surgical implants for the orthopedic market. The Company acquired CPM Medical Consultants, LLC (“CPM”) in December 2017 (the “CPM Acquisition”), in which the Company was the legal acquirer and CPM was deemed the accounting acquirer. In August 2018, the Company completed the acquisition of Palm Springs Partners, LLC d/b/a Maxim Surgical (“Maxim” and such transactions the “Maxim Acquisition”). CPM and Maxim survive as the Company’s wholly-owned subsidiaries and subsequent to the completion of each acquisition, CPM, Maxim and Company operations are consolidated.

Basis of Presentation

The interim unaudited condensed consolidated financial statements included herein reflect all material adjustments (consisting of normal recurring adjustments and reclassifications and non-recurring adjustments) which, in the opinion of the Company’s management, are ordinary and necessary for a fair presentation of results for the interim periods. Certain information and footnote disclosures required under generally accepted accounting principles in the United States of America (“GAAP”) have been condensed or omitted pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”). The Company’s management believes the disclosures are adequate to make the information presented not misleading.

The condensed consolidated balance sheet information as of December 31, 2019, was derived from the Company’s annual report on Form 10-K for the fiscal year ended December 31, 2019 (“2019 Annual Report”), filed with the SEC pursuant to Section 13 or 15(d) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), on March 30, 2020. These interim unaudited condensed consolidated financial statements should be read in conjunction with the 2019 Annual Report.

The results of operations for the three and six months ended June 30, 2020 are not necessarily indicative of the results to be expected for the entire fiscal year or for any other period as the Company has historically experienced seasonal trends with greater revenue and volume between the last two calendar quarters compared to the first two calendar quarters of the year.

Going Concern

The accompanying interim unaudited condensed consolidated financial statements have been prepared as if the Company will continue as a going concern. Through June 30, 2020, the Company has accumulated losses of $4,303,243 and a stockholders’ deficit of $2,602,465. Revenue declined by $1,065,259 in the second quarter of 2020 compared to the same quarter in 2019, as the Company has been impacted by restrictions as a result of the novel coronavirus SARS-CoV-2 global pandemic (“COVID-19”). At various times during the years ended December 31, 2018 and 2019 and in the first quarter ended March 31, 2020, the Company was out of compliance with one or more covenants contained in its Amended and Restated Business Loan Agreement (“RLOC”) with ZB, N.A., d/b/a Amegy Bank (“Amegy Bank”), but obtained waivers from Amegy Bank to cure the violations, resulting in reductions in the Company’s aggregate contractual borrowing limits under the RLOC. The RLOC functions as a senior secured revolving loan facility. The Company’s management has determined that these conditions and events raise substantial doubt about the ability of the Company to continue as a going concern.

The Company’s ability to continue as a going concern for at least one year beyond the date of this filing is dependent upon the easing of restrictions imposed on elective surgeries by governmental authorities as a result of COVID-19, as well as the Company’s, (i) successful execution of key branding initiatives, (ii) introduction, commercialization and sales of new proprietary products and product lines, (iii) increased sales of existing products, with strategic emphasis on direct sales to medical facilities (“Retail Cases”), and increasing the percentage of Retail Cases sold as a percentage of all cases sold by the Company (sales volume based on medical procedures in which the Company’s products are sold and used “Cases”), and (iv) continued cost reductions. Additionally, the Company will need to refinance its RLOC with Amegy Bank with a new credit facility on commercially reasonable terms, or obtain financing.

The interim unaudited condensed consolidated financial statements of the Company do not include any adjustments relating to the recoverability and classification of recorded assets, or the amounts and classifications of liabilities that might be necessary should the Company be unable to continue as a going concern.

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FUSE MEDICAL, INC.

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(Unaudited)

Note 2. Significant Accounting Policies

Principles of Consolidation

The unaudited condensed consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries, CPM and Maxim. Intercompany transactions have been eliminated in consolidation.

Use of Estimates

The preparation of the interim unaudited condensed consolidated financial statements in accordance with GAAP, requires the Company’s management to make estimates and assumptions that affect the Company’s reported amounts in the interim unaudited condensed consolidated financial statements.

Actual results could differ from those estimates. Significant estimates on the accompanying interim unaudited condensed consolidated financial statements include the allowance for doubtful accounts, valuation of inventories, the Company’s effective income tax rate, and the recoverability of deferred tax assets, which are based upon the Company management’s expectation of future taxable income and allowable deductions and the fair value calculations of stock-based compensation, goodwill, finite lived intangibles and the earn-out liability.

Reclassifications

Long term accounts receivable, net of allowance was previously reported as a component of current assets as accounts receivable, net of allowance in the Company’s accompanying interim unaudited condensed consolidated balance sheets. Long term accounts receivable reflects Cases where the patient has obtained a letter of protection, (“LOP”). A LOP is a contract that provides that the medical providers will be paid from any proceeds received from settlement of litigation of the underlying cause of action with respect to the event that necessitated medical goods and services. Once the medical provider receives payment, then the medical provider pays our invoice which payment is generally greater than 365 day from date of service. The LOP provides medical providers with greater certainty of full payment. This reclassification had no effect on the previously reported total assets or net loss.  

Segment Reporting

In accordance with Accounting Standards Codification (“ASC”) No. 280, “Segment Reporting,” the Company uses the management approach for determining its reportable segments. The management approach is based upon the way that management reviews performance and allocates resources. The Company’s Chief Executive Officer serves as the Company’s chief operating decision maker, and his management team reviews operating results on a consolidated basis for purposes of allocating resources and evaluating the financial performance of the Company. The Company has integrated the operations of both CPM and Maxim. Accordingly, the Company has determined that it has one operating segment and, therefore, one reporting segment.

Earnings (loss) Per Common Share

Earnings (loss) per common share, basic is calculated by dividing the net income/(loss) attributable to common stockholders by the weighted-average number of common stock, par value $0.01, (“Common Stock”), outstanding during the period, without consideration of Common Stock equivalents. Shares of restricted stock are included in the basic weighted-average number of Common Stock outstanding from the time they vest.

Diluted earnings (loss) per common share is computed by dividing net income/(loss) by the weighted-average number of Common Stock equivalents outstanding for the period determined using the treasury stock method. For the six months ended June 30, 2020 and 2019, the Company excluded the effects of outstanding stock options, convertible notes and, to the extent in the money, restricted stock as their effects were antidilutive due to the Company’s operating loss during these periods.  

For the six months ended June 30, 2020, restricted stock and Common Stock equivalents of 4,777,892 have been excluded from diluted earnings per share because to include them would have been antidilutive. (see Note 9, “Stockholders’ Equity” for the terms and conditions of restricted stock)

Fair Value Measurements

Fair value is the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants. The Company classifies assets and liabilities recorded at fair value under the fair value hierarchy based upon the observability of inputs used in valuation

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techniques. Observable inputs (highest level) reflect market data obtained from independent sources, while unobservable inputs (lowest level) reflect internally developed market assumptions. The fair value measurements are classified under the following hierarchy:

Level 1—Observable inputs that reflect quoted market prices (unadjusted) for identical assets and liabilities in active markets;

Level 2—Observable inputs, other than quoted market prices, that are either directly or indirectly observable in the marketplace for identical or similar assets and liabilities, quoted prices in markets that are not active, or other inputs that are observable or can be corroborated by observable market data for substantially the full term of the assets and liabilities; and

Level 3—Unobservable inputs that are supported by little or no market activity that are significant to the fair value of assets or liabilities.

In connection with the CPM Acquisition in December 2017, the Company recorded an earn-out liability as part of the purchase consideration. The fair value of the earn-out liability is re-measured at each reporting period using Level 3 inputs with changes in fair value recorded in earnings. The earn-out payments are based on the financial performance of the Company between January 1, 2018, and December 31, 2034. The base amount of the earn-out ranges from $0.00 to $16,000,000 with an additional bonus payment of $10,000,000 subject to the Company meeting certain earnings thresholds as defined in the CPM Acquisition Agreement. The fair value of the earn-out liability was calculated using the Monte Carlo simulation, which was then applied to estimated earn-out payments. There was no change in the earn-out liability for the six months ended June 30, 2020 and there were no significant changes in the Level 3 inputs from those utilized at December 31, 2019. The required earnings thresholds have not been met from inception of the agreements through June 30, 2020, and as such, there have been no payments required for either the base or bonus earn-out tranches.

Financial Instruments

The estimated fair value of certain financial instruments, including cash and cash equivalents, accounts receivable, accounts payable and accrued expenses are carried at historical cost basis, which approximates their fair values because of the short-term nature of these instruments. The recorded values of notes payable approximate their respective fair values based upon their effective interest rates.

Cash and Cash Equivalents

The Company considers highly liquid investments with maturities of three months or less at the time of purchase to be cash equivalents.  There were no cash equivalents at June 30, 2020 and December 31, 2019.  The Company’s cash is concentrated in large financial institutions that at times may exceed federally insured limits of $250,000 per financial institution.  The Company has not experienced any financial institution losses from inception through June 30, 2020.  As of June 30, 2020 and December 31, 2019, there were deposits of $861,703 and $599,309, respectively, greater than federally insured limits.

Accounts Receivable and Allowances

Accounts receivable are non-interest bearing and are stated at gross invoice amounts less an allowance for doubtful accounts receivable and an allowance for contractual discount pricing. Credit is extended to customers based on an evaluation of their financial condition, industry reputation, and other factors considered by the Company’s management. The Company generally does not require collateral or other security interest to support accounts receivable. Based on trends and specific factors, the customer’s credit terms may be modified, including required payment upon delivery.

The Company performs regular on-going credit evaluations of its customers as deemed relevant. As events, trends, and circumstances warrant, the Company’s management estimates the amounts that are more likely than not to be uncollectible. These amounts are recognized as bad debt expense and are reflected within selling, general, administrative and other expenses on the Company’s accompanying interim unaudited condensed consolidated statements of operations.

When accounts are deemed uncollectible, they are often referred to the Company’s outside legal firm for litigation. Accounts deemed uncollectible are written-off in the period when the Company has exhausted its efforts to collect overdue and unpaid receivables or otherwise has evaluated other circumstances that indicate that the Company should abandon such efforts. Accounts deemed uncollectible are removed from the Company’s accounts receivable portfolio, with a corresponding offset to the allowance for doubtful accounts receivable. The Company may record additional allowances for doubtful accounts based on known trends and expectations to ensure the Company’s accounts receivable portfolio is recorded at net realizable value. Specific allowances are re-evaluated and adjusted as additional facts and information become available. Previously written-off accounts receivable subsequently collected are recognized as a reduction of bad debt expense when funds are received.

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NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

The Company’s management estimates its allowance for contractual discount pricing, by evaluating specific accounts where information indicates the customer is offered contractual pricing and discount allowances. In these arrangements, the Company’s management uses assumptions and judgement, based on the best available facts and circumstances to record a specific allowance for the amounts due from those customers. The allowance is offset by a corresponding reduction to revenue. These specific allowances are re-evaluated, analyzed, and adjusted as additional information becomes available to determine the total amount of the allowance. The Company may record additional allowances based on trends and expectations to ensure the Company’s accounts receivable portfolio is recorded at net realizable value.

Inventories

Inventories are stated at the lower of cost or net realizable value (first-in, first-out) which includes an allowance for slow-moving inventory, expired inventory, and inventory obsolescence. Inventories consist entirely of finished goods and include internal and external fixation products; upper and lower extremity plating and total joint reconstruction; soft tissue fixation and augmentation for sports medicine procedures; spinal implants for trauma, degenerative disc disease, and deformity indications (collectively, “Orthopedic Implants”) and osteo-biologics and regenerative tissue which include human allografts, substitute bone materials, tendons, and amniotic tissues and fluids (collectively, “Biologics”). The Company reviews the market value of inventories whenever events and circumstances indicate that the carrying value of inventories may not be recoverable from the estimated future sales price less cost of disposal and normal gross profit. In cases where the market values are less than the carrying value, a write-down is recognized equal to an amount by which the carrying value exceeds the market value of inventories.

Property and Equipment

Property and equipment are recorded at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the related assets per the following table. Expenditures for additions and improvements are capitalized, while repairs and maintenance are expensed as incurred. The Company reviews long-lived assets for impairment annually or whenever changes in circumstances indicate that the carrying amount of an asset might not be recoverable.

Upon the retirement or disposition of property and equipment, the related cost and accumulated depreciation is removed. A gain is recorded when consideration received is more than the disposed asset’s cost, net of depreciation, and a loss is recorded when consideration received is less than the disposed asset’s cost, net of depreciation.

Long-Lived Assets

The Company reviews other long-lived assets for indicators of impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The evaluation is performed at the lowest level of identifiable cash flows, which is at the individual asset level or the asset group level. The undiscounted cash flows expected to be generated by the related assets are estimated over their useful life based on updated projections. If the evaluation indicates that the carrying amount of the assets may not be recoverable, any potential impairment is measured based upon the fair value of the related assets or asset group as determined by an appropriate market appraisal or other valuation technique. Assets classified as held for sale, if any, are recorded at the lower of carrying amount or fair value less costs to sell.

Goodwill and Other Intangible Assets

Goodwill is determined based on an acquisition purchase price in excess of the fair value of identified net assets acquired.  Intangible assets with lives restricted by contractual, legal or other means are amortized over their useful lives. 

Goodwill is not amortized but is tested in the fourth quarter each year for impairment, or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of the reporting unit below its carrying amount.  The Company performs its annual, or interim, goodwill impairment test by comparing the fair value of a reporting unit with its carrying amount. If the carrying value of a reporting unit exceeds its fair value, an impairment charge is recognized for the amount by which the carrying amount exceeds the reporting unit’s fair value. As of June 30, 2020, the Company evaluated certain qualitative factors

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FUSE MEDICAL, INC.

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(Unaudited)

including, (i) macroeconomic factors resulting from the COVID-19 pandemic, (ii) the Company’s operating loss and overall financial performance, (iii) the Company’s stock price, and (iv) specific cost-saving actions taken by the Company in response to the COVID-19 pandemic in concluding that the reported amount of goodwill was not more likely than not impaired.

Accounting Standards Update (“ASU”) 350-30-35-18 indicates that an intangible asset that is not subject to amortization shall be tested for impairment annually and more frequently if events or changes in circumstances indicate that it is more likely than not that the asset is impaired.  The Company’s 510(k) intangible asset has an indefinite life. The Company does not believe that an important triggering event has occurred as of June 30, 2020.

The Company’s intangible assets subject to amortization consist primarily of acquired non-compete agreements and customer relationships. Amortization expense is calculated using the straight-line method over the asset’s expected useful life.

Revenue Recognition

The Company’s revenues are generated from the sales of Orthopedic Implants and Biologics to support orthopedic surgeries. The Company obtains purchase orders from its customers for the sale of its products which sets forth the general terms and conditions including line item pricing and payment terms (generally due upon receipt). The Company recognizes revenue when its customers obtain control over the assets (generally when the title passes upon shipment or when a product is utilized in a surgery) and it is probable that the Company will collect substantially all the amounts due. Individual promised goods are the Company’s only performance obligation.

Due to the nature of its products, the Company’s product returns have been historically immaterial.

The Company includes shipping and handling fees in net revenues. Shipping and handling costs, associated with outbound freight after control over a product has transferred to a customer are accounted for as a fulfillment cost and are included in cost of goods sold on the Company’s accompanying interim unaudited condensed consolidated statements of operations.

Revenue Differentiation

The Company measures sales volume based on medical procedures in which the Company’s products are sold and used (Cases). The Company considers Cases resulting from direct sales to medical facilities to be Retail Cases and Cases resulting from sales to third parties, such as non-medical facilities, distributors, or sub-distributors, to be wholesale cases (“Wholesale Cases”). Some of the Company’s sales for Wholesale Cases are on a consignment basis with a third party. When consigned, the revenue is not recorded until the device is implanted in a patient during surgery. In the Company’s industry, Retail Cases are typically sold at higher price points than Wholesale Cases, resulting in greater revenue and gross profit per Case.

Cost of Revenues

Cost of revenues consists of (i) cost of goods sold, (ii) freight and shipping costs for items sold to customers, (iii) cost of storage, (iv) investment in medical instruments, which are expensed when acquired, (v) inventory shrink, and (vi) an estimate for slow-moving and expired inventory, and inventory obsolescence.

Stock-Based Compensation

Stock-based compensation expense is measured at the grant date fair value of the award and is expensed over the requisite service period. For employee stock-based awards, the Company calculates the fair value of the award on the date of grant using the Black-Scholes option pricing model. Determining the fair value of stock-based awards at the grant date under this model requires judgment, including estimating volatility, employee stock option exercise behaviors and forfeiture rates. The assumptions used in calculating the

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fair value of stock-based awards represent the Company's best estimates, but these estimates involve inherent uncertainties and the application of management judgment. For non-employee stock-based awards, the Company calculates the fair value of the award on the date of grant in the same manner as employee awards, however, the awards are revalued at the end of each reporting period and the pro-rata compensation expense is adjusted accordingly until such time the non-employee award is fully vested, at which time the total compensation recognized to date shall equal the fair value of the stock-based award as calculated on the measurement date, which is the date at which the award recipient’s performance is complete. The estimation of stock-based awards that will ultimately vest requires judgment, and to the extent actual results or updated estimates differ from original estimates, such amounts are recorded as a cumulative adjustment in the period estimates are revised.

Recent Accounting Pronouncements

Accounting pronouncements issued or effective in 2020 by the Financial Accounting Standards Board (the “FASB”), did not or are not believed by the Company’s management to have a material impact on the Company's present or future unaudited condensed consolidated financial statements.

Depreciation expense for the three months ended June 30, 2020 and 2019 was $10,397 and $5,241, respectively. Depreciation expense for the six months ended June 30, 2020 and 2019 was $20,025 and $10,610, respectively.

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FUSE MEDICAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Amortization expense for the three months ended June 30, 2020 and 2019 was $20,355 and $20,355, respectively. Amortization expense for the six months ended June 30, 2020 and 2019, was $40,710 and $40,710.

The Company’s intangible assets subject to amortization consist primarily of acquired non-compete agreements, and customer relationships.

Note 5. Senior Secured Revolving Credit Facility

Effective December 29, 2017, the Company became party to its RLOC with Amegy Bank. The RLOC contains customary representation, warranties, covenants, events of default, and is collateralized by substantially all of the Company’s assets. The Company’s Chairman of the Board of Directors (“Board”) and President initially personally guaranteed fifty percent (50%) of the outstanding RLOC amount.

On September 21, 2018, the Company executed the First Amendment to the RLOC with Amegy Bank (the “First Amendment”). The First Amendment (i) waived the Company’s events of default under the RLOC through the fiscal quarter ended September 30, 2018, and (ii) added a covenant that the Company achieve quarterly net income of $700,000 or more for the fiscal quarter ending on September 30, 2018.

On November 19, 2018, the Company executed the Second Amendment to the RLOC with Amegy Bank (the “Second Amendment”). The Second Amendment (i) waived the Company’s events of default under the RLOC, (ii) reduced the aggregate limit of the RLOC to $4,000,000, (iii) extended the maturity date to November 4, 2019, (iv) revised the variable interest rate to the one-month LIBOR rate plus four percent (4.00%) per annum, and (v) amended the financial covenants to state that the Company will not permit the Fixed Charge Coverage Ratio of any calendar quarter end from and after the quarter ending June 30, 2019, to be less than 1.25 to 1.00; EBITDA to be less than $700,000 for the fiscal quarter ending December 31, 2018, and $100,000 for the fiscal quarter ending March 31, 2019; modified the event of default related to consecutive quarterly losses to be applicable from and after the quarter ending June 30, 2019.

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FUSE MEDICAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

On May 9, 2019, the Company executed the Third Amendment to the RLOC with Amegy Bank (the “Third Amendment”). Pursuant to the Third Amendment Amegy Bank (i) waived the Company’s events of default under the RLOC, (ii) reduced the aggregate limit of the RLOC to $3,500,000, (iii) reduced the limit of credit card exposure to $500,000, (iv) reduced borrowing base component of inventory to 30%, (v) amended the financial covenants to state that the Company will not permit EBITDA to be less than $100,000 for the fiscal quarter ending June 30, 2019 and $500,000 for the fiscal quarter ending September 30, 2019 and (vi) rescinded the Loan Sweep Feature, requiring the Company to give notice of each requested loan by delivery of Advance Request to Amegy Bank.

On December 18, 2019, the Company executed the Fourth Amendment to the RLOC with Amegy Bank (the “Fourth Amendment”). Pursuant to the Fourth Amendment, Amegy Bank (i) waived the Company’s events of default under the RLOC, (ii) reduced the aggregate limit of the RLOC to $2,750,000, (iii) reduced and limited the annual salary of the Company’s Chairman of the Board and President, Mark W. Brooks (“Mr. Brooks”), to not exceed $550,000, (iv) amended the financial covenants to state that the Company will not permit EBITDA to be less than $600,000 for the fiscal quarter ending December 31, 2019 and $125,000 for the fiscal quarter ending March 31, 2020, (v) extended the termination date of the RLOC to May 4, 2020 and (vi) provided for our Chairman of the Board and President to personally guarantee one hundred percent (100%) of the outstanding RLOC amount.

On May 21, 2020, the Company executed the Fifth Amendment to the RLOC with Amegy Bank (“the Fifth Amendment”). Pursuant to the Fifth Amendment, Amegy Bank (i) waived the Company’s events of default under the RLOC, (ii) amended the financial covenants to state that the Company will not permit EBITDA to be less than $25,000 for the six months ended September 30, 2020, and (iii) extended the termination date of the RLOC until November 4, 2020.

In conjunction with executing the Fifth Amendment to the RLOC, the Company obtained an additional $200,000 in capital in the form of subordinated debt from affiliates of Messrs. Brooks and Reeg. Specifically, on May 6, 2020, the Company borrowed $180,000 from NC 143 Family Holdings, LP (“NC 143”), a limited partnership controlled by Mr. Brooks, the Company’s President and Chairman of the Board, and $20,000 from Reeg Medical Industries, Inc. (“RMI”), a company owned and controlled by Christopher C. Reeg (“Mr. Reeg”), the Company’s Chief Executive Officer and Secretary, in exchange for two promissory notes which are unsecured, bear interest at 0.25% per annum until May 6, 2022, the maturity date, and 10.0% per annum after the maturity date, if not paid in full.  Principal and interest are due and payable on the maturity date, provided, however, any payment of principal and interest on the loans is subordinated to payment of all indebtedness under the RLOC.

For the three months ended June 30, 2020, the Company was in compliance with the covenants of its RLOC with Amegy Bank.

The outstanding balance of the RLOC was $1,088,352 and $1,752,501 at June 30, 2020 and December 31, 2019, respectively. Interest expense incurred on the RLOC was $15,363 and $21,295 for the three months ended June 30, 2020 and 2019, respectively, and is reflected in interest expense on the Company’s accompanying unaudited condensed consolidated statements of operations. Interest expense incurred on the RLOC was $39,633 and $40,073 for the six months ended June 30, 2020 and 2019, respectively. Accrued interest on the RLOC at June 30, 2020 and December 31, 2019 was $4,053 and $4,437, respectively, and is reflected in accrued expenses on the Company’s accompanying interim unaudited condensed consolidated balance sheets. At June 30, 2020, the effective interest rate was 5.1%.

Note 6. Notes Payable – Related Parties

During July 2016 through October 2016, the Company obtained three working capital loans from NC 143 and RMI in the form of convertible promissory notes (“Notes”) in the aggregate amount of $150,000 bearing ten percent (10%) interest per annum until December 31, 2016 (“Maturity Date”), and eighteen percent (18%) interest per annum for periods subsequent to the Maturity Date. The Notes remain outstanding and principal and interest are due and payable upon demand of the payee and at the holder’s sole discretion. The Notes’ holders have the right to convert all or any portion of the then unpaid principal and interest balance into shares of the Company’s Common Stock at a conversion price of $0.08 per share.  On May 6, 2020, the Company borrowed $180,000 from NC 143 and $20,000 from RMI, in exchange for two promissory notes which are unsecured, bear interest at 0.25% per annum until May 6, 2022, the maturity date, and 10.0% per annum after the maturity date, if not paid in full.  Principal and interest are due and payable on the maturity date, provided, however, any payment of principal and interest on the loans is subordinated to payment of all indebtedness under the RLOC.

During the three months ended June 30, 2020 and 2019, interest expense of $6,732 and $ 6,732, respectively, is reflected in interest expense on the Company’s accompanying unaudited condensed consolidated statements of operations. During the six months ended June 30, 2020 and 2019, interest expense of $13,463 and $13,389, respectively, is reflected in interest expense on the Company’s accompanying unaudited condensed consolidated statements of operations. As of June 30, 2020, and December 31, 2019, accrued

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FUSE MEDICAL, INC.

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(Unaudited)

interest was $99,559 and $86,096, respectively, which is reflected in accrued expenses on the Company’s accompanying unaudited condensed consolidated balance sheets.

Note 7 – Paycheck Protection Program

On April 11, 2020, the Company received approval from the U.S. Small Business Administration (“SBA”) to fund the Company’s request for a loan under the Paycheck Protection Program (“PPP Loan”) created as part of the recently enacted Coronavirus Aid, Relief, and Economic Security Act (“CARES Act”) administered by the SBA. In connection with the PPP Loan, the Company has entered into a promissory note in the principal amount of $361,400. In accordance with the requirements of the CARES Act, the Company intends to use the proceeds from the PPP Loan primarily for payroll costs. The PPP Loan is scheduled to mature on April 11, 2022, has a 1.00% interest rate, and is subject to the terms and conditions applicable to all loans made pursuant to the Paycheck Protection Program as administered by the SBA under the CARES Act. The PPP Loan is reflected in short term liabilities in the Company’s accompanying interim unaudited condensed consolidated balance sheets as the Company expects the PPP Loan will be forgiven during 2020.

As of June 30, 2020, the Company incurred approximately $900 in accrued interest related to the PPP Loan, which is reflected in accrued expenses on the Company’s accompanying interim unaudited condensed consolidated balance sheets. The Company did not incur accrued interest expense on the PPP Loan as of June 30, 2019. For the three months and six months ended June 30, 2020, the Company incurred approximately $900 in interest expense related to the PPP Loan, which is reflected in interest expense on the Company’s statements of operations. The Company did not incur interest expense related to the PPP Loan for the three and six months ended June 30, 2019.

Note 8 – Economic Injury Disaster Loan

On May 12, 2020, the Company executed the standard loan documents required for securing a loan from the SBA under its Economic Injury Disaster Loan assistance program (the “EIDL Loan”) in light of the impact of the COVID-19 pandemic on the Company’s business. Pursuant to the Loan Authorization and Agreement (the “SBA Loan Agreement”), the principal amount of the EIDL Loan was $150,000, with proceeds to be used for working capital purposes. Interest accrues at the rate of 3.75% per annum. Installment payments, including principal and interest, are due monthly beginning May 12, 2021 (twelve months from the date of the SBA Loan Agreement) in the amount of $731. The balance of principal and interest is payable thirty years from the date of the SBA Loan Agreement. The EDIL Loan is reflected in long term liabilities in the Company’s accompanying interim unaudited condensed consolidated balance sheets. In connection therewith, the Company received a $10,000 advance, which does not have to be repaid and is reflected as an offset in Selling, General, Administrative and Other Expenses in the Company’s accompanying interim unaudited condensed consolidated statements of operations.

As of June 30, 2020, the Company incurred approximately $940 in accrued interest related to the EIDL Loan, which is reflected in accrued expenses on the Company’s accompanying interim unaudited condensed consolidated balance sheets. The Company did not incur accrued interest expense on the EIDL Loan as of June 30, 2019. For the three months and six months ended June 30, 2020, the Company incurred approximately $940 in interest expense related to the EIDL Loan, which is reflected in interest expense on the Company’s statements of operations. The Company did not incur interest expense related to the EIDL Loan for the three and six months ended June 30, 2019.

Note 9. Stockholders’ Equity

Stock-Based Compensation

The 2018 Amended and Restated Equity Incentive Plan of Fuse Medical, Inc. (“2018 Equity Plan”) is the Company’s stock-based compensation plan, which the Company’s Board adopted on April 5, 2017, and subsequently amended and restated on December 13, 2018. The 2018 Equity Plan provides for the granting of equity awards, including qualified incentive and non-qualified stock options, stock appreciation awards, and restricted stock awards to employees, directors, consultants, and advisors. Awards granted pursuant to the 2018 Equity Plan are subject to a vesting schedule set forth in individual agreements.

The Company’s management estimates the fair value of stock-based compensation utilizing the Black-Scholes option pricing model. Black-Scholes option pricing is calculated using several variables, including the expected option term, expected volatility of the Company’s stock price over the expected option term, expected risk-free interest rate over the expected option term, expected dividend yield rate over the expected option term, and an estimate of expected forfeiture rates. The Company’s management believes

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(Unaudited)

this valuation methodology is appropriate for estimating the fair value of stock options granted to employees and directors, which are subject to ASC Topic 718 requirements. The Company’s management estimates of fair value may not be reflective of actual future values or amounts ultimately realized by recipients of these grants. The Company recognizes compensation on a straight-line basis over the requisite service period for each award.

The Company’s management utilizes the simplified method to estimate the expected life for stock options granted to employees, as the Company does not have sufficient historical data regarding stock option exercises. The risk-free interest rate is based on the U.S. Treasury yields with terms equivalent to the expected life of the related option at the time of the grant. Dividend yield is based on historical trends. While the Company’s management believes these estimates are reasonable, the compensation expense recorded would increase if the expected life was increased, a higher expected volatility was used, or if the expected dividend yield increased.

The Company made an accounting policy election to account for forfeitures when they occur, versus estimating the number of awards that are expected to vest, in accordance with ASU 2016-09, “Improvements to Employee Share-Based Payment Accounting.”

Non-Qualified Stock Option Awards

For the three and six months ended June 30, 2019 the Board granted 300,000 and 1,200,000 Non-qualified Stock Option (“NQSO”) to the Company’s product advisory board members, certain key employees and marketing representatives. For the three and six months ended June 30, 2020, the Board did not grant any NQSOs. For the three months ended June 30, 2020 and June 30, 2019 the Company amortized $164,443 and $254,699 relating to the vesting of stock options which is included in selling, general, administrative, and other expenses on the Company’s accompanying interim unaudited condensed consolidated statement of operations. For the six months ended June 30, 2020 and June 30, 2019 the Company amortized $327,098 and $499,107 relating to the vesting of stock options which is included in selling, general, administrative, and other expenses on the Company’s accompanying interim unaudited condensed consolidated statements of operations.  The Company will recognize $798,661 as an expense in future periods as the stock options vest. The Company recognizes stock compensation expense on a straight-line basis over the requisite service period for each award, which are subject to a vesting schedule as set forth in individual agreements.

A summary of the Company’s stock option activity for the six months ended June 30, 2020, is presented below:

 Restricted Common Stock

The non-vested restricted stock awards (“RSA”s), as of June 30, 2020, were granted to the Company’s Board members as compensation. These awards vest only upon: (i) the occurrence of one of the Accelerating Events: (a) a Change in Control (as defined in RSA Agreement); or (b) listing of the Company’s Common Stock on either NYSE or NASDAQ Stock Market; and (ii) the director’s delivery to the Company a Notice of Acceleration of Vesting (as defined in RSA Agreement), within the Acceleration Notice Period (as defined in RSA Agreement).

As of June 30, 2020, and 2019, it was not probable that the performance conditions on the outstanding RSAs would be met, therefore, no expense has been recorded for these awards for the three and six months ended June 30, 2020 and 2019.

There were no RSA’s that were granted, exercised, or forfeited during the six months ended June 30, 2020.

F-14

Significant components of the Company's deferred income tax assets and liabilities are as follows:

F-15

FUSE MEDICAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

A reconciliation of income tax computed at the U.S. statutory rate to the effective income tax rate is as follows:

Our effective income tax rates for the six months ended June 30, 2020 and 2019 were (0.4%) and 19.2%, respectively. The decrease from the prior period was driven by the valuation allowance allocated to the deferred tax asset for the current period.

At June 30, 2020 and December 31, 2019, the following significant customers had a concentration of accounts receivable representing ten percent (10%) or greater of accounts receivable:

F-16

FUSE MEDICAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

For the six months ended June 30, 2020 and 2019, the following significant suppliers represented ten percent (10%) or greater of goods purchased:

Note 12. Related Party Transactions

Lease with 1565 North Central Expressway, LP

For its principal executive office, the Company leases an aggregate of approximately 11,500 square-foot space at 1565 North Central Expressway, Suite 220, Richardson, Texas 75080 from 1565 North Central Expressway, LP (“NCE, LP”), a real estate investment company that is owned and controlled by Mr. Brooks. The Company’s lease arrangement includes (i) the lease acquired pursuant to the CPM Acquisition effective January 1, 2013, and (ii) a lease effective July 14, 2017 entered into to support the Company’s relocation of its Fort Worth, Texas corporate offices to CPM’s executive offices. Both leases terminated December 31, 2017, with month-to-month renewals thereafter.

For the six months ended June 30, 2020 and 2019, the Company paid approximately $84,000 and $84,000, respectively, in rent expense, which is reflected in selling, general, administrative, and other expenses in the Company’s accompanying interim unaudited condensed consolidated statements of operations.

AmBio Contract

The Company engaged AmBio Staffing, LLC (“AmBio”), a Texas licensed Professional Employment Organization, to provide payroll processing, employee benefit administration, and related human capital services effective January 1, 2017. Mr. Brooks owns and controls AmBio. As of June 30, 2020, AmBio operations support approximately 41 full time equivalents (“FTE”). Of those 41 FTEs, 34 FTEs directly support the Company, 7 FTEs support the operations of other companies, and no FTEs are shared between the Company and other companies.

As of June 30, 2020 and December 31, 2019, the Company owed amounts to AmBio of approximately $130,000 and $170,000, respectively, which are reflected in accounts payable on the Company’s unaudited condensed consolidated balance sheets. For the six months ended June 30, 2020 and June 30, 2019, the Company paid approximately $89,000  and $105,000, respectively, to AmBio in administrative fees, which are reflected in selling, general, administrative, and other expenses in the Company’s accompanying unaudited condensed consolidated statements of operations.  

Operations

Historically, the Company conducts various related-party transactions with entities that are owned by or affiliated with Mr. Brooks and Mr. Reeg. These transactions are based on wholesale contractual agreements that the Company’s management believes are on terms and conditions substantially similar to other third-party contractual agreements. As described more fully below, these transactions include: selling and purchasing of inventory on a wholesale basis, commissions earned and paid and shared-service fee arrangements.

MedUSA Group, LLC

MedUSA Group, LLC (“MedUSA”) is a sub-distributor owned and controlled by Mr. Brooks and Mr. Reeg.

During the six months ended June 30, 2020 and 2019, the Company:

F-17

FUSE MEDICAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

As of June 30, 2020 and December 31, 2019, the Company had approximately $470,000 and $598,000, respectively, of unpaid commission costs due to MedUSA, which is reflected in accrued liabilities in the Company’s accompanying condensed consolidated balance sheets.

As of June 30, 2020 and December 31, 2019, the Company had outstanding balances due from MedUSA of approximately $585,000 and $555,000, respectively. These amounts are reflected in accounts receivable, net of allowance in the Company’s accompanying condensed consolidated balance sheets.

Texas Overlord, LLC

Texas Overlord, LLC (“Overlord”) is an investment holding-company owned and controlled by Mr. Brooks.

During the six months ended June 30, 2020 and 2019, the Company:

As of June 30, 2020 and December 31, 2019, the Company had approximately $30,000 and $15,000 of unpaid commissions costs owed to Overlord, which are reflected in accrued liabilities in the Company’s accompanying condensed consolidated balance sheets.

As of June 30, 2020 and December 31, 2019, the Company had no outstanding balances due from Overlord.

NBMJ, Inc.

NBMJ, Inc. d/b/a Incare Technology (“NBMJ”) is a durable medical equipment, wound care, and surgical supplies distributor owned and controlled by Mr. Brooks.

During the six months ended June 30, 2020 and 2019, the Company sold Biologics products to NBMJ in the amounts of approximately $12,000, and $364,000, respectively, which are reflected in net revenues in the Company’s accompanying interim unaudited condensed consolidated statements of operations.

As of June 30, 2020 and December 31, 2019, the Company had no outstanding balances due from NBMJ.

Payment terms per the stocking and distribution agreement with NBMJ are 30 days from receipt of invoice.

Bass Bone and Spine Specialists

Bass Bone & Spine Specialists (“Bass”) operates as a sub-distributor of surgical implants and is owned and controlled by Mr. Brooks.

During the six months ended June 30, 2020 and 2019, the Company:

As of June 30, 2020 and December 31, 2019, the Company had outstanding balances due from Bass of approximately $26,000 and $7,000, respectively. These amounts are reflected in accounts receivable, net of allowance, in the Company’s accompanying condensed consolidated balance sheets.

Payment terms per the stocking and distribution agreement with Bass are 30 days from receipt of invoice.

Sintu, LLC

Sintu, LLC (“Sintu”) operates as a sub-distributor of surgical implants and is owned and controlled by Mr. Brooks.

F-18

FUSE MEDICAL, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

During the six months ended June 30, 2020 and 2019, the Company incurred approximately $279,000 and $174,000, respectively, in commission costs to Sintu, which are reflected in commissions on the Company’s accompanying interim unaudited condensed consolidated statements of operations.

Tiger Orthopedics, LLC

Tiger Orthopedics, LLC (“Tiger”) operates as a sub-distributor of surgical implants and is owned and controlled by Mr. Brooks.

During the six months ended June 30, 2020 and June 30, 2019, the Company sold Orthopedic Implants and Biologics products to Tiger in the amounts of approximately $39,000 and $132,000, respectively, which are reflected in net revenues in the Company’s accompanying interim unaudited condensed consolidated statements of operations.

As of June 30, 2020, and December 31, 2019, the Company had outstanding balances due from Tiger of approximately $5,000 and $30,000, respectively. These amounts are reflected in accounts receivable, net of allowance, in the Company’s accompanying condensed consolidated balance sheets.

Payment terms per the stocking and distribution agreement with Tiger are 30 days from receipt of invoice.

Modal Manufacturing, LLC

Modal Manufacturing, LLC (“Modal”) is a manufacturer of medical devices owned and controlled by Mr. Brooks.

During the six months ended June 30, 2020 and 2019, the Company purchased approximately $318,000 and $481,000, respectively, in Orthopedic Implants and medical instruments from Modal, which are reflected within inventories, net of allowance in the Company’s accompanying interim unaudited condensed consolidated balance sheets.

As of June 30, 2020 and December 31, 2019, the Company had outstanding balances owed to Modal of approximately $277,000 and $0, respectively. These amounts are reflected in accounts payable in the Company’s accompanying condensed consolidated balance sheets.

As of June 30, 2020 and December 31, 2019, the Company had outstanding balances due from Modal of approximately $0 and $40,700, respectively. These are reflected in accounts receivable, net of allowance, in the Company’s accompanying condensed consolidated balance sheets.

Payment terms per the stocking and distribution agreement with Modal are 30 days from receipt of invoice.