Catheter Precision, Inc. - Quarter Report: 2019 June (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended June 30, 2019

OR

For the Transition Period From              to

Commission file number: 001-38677

Ra Medical Systems, Inc.

(Exact name of Registrant as specified in its charter)

(760) 804-1648

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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

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.

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 20, 2019, the registrant had 13,407,995 shares of common stock, par value $0.0001 per share, outstanding.

RA MEDICAL SYSTEMS, INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

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EXPLANATORY NOTE

We were unable to timely file our Quarterly Report on Form 10-Q for the second quarter ended June 30, 2019 due to the previously reported Audit Committee investigation, which has now been substantially completed, and the previously reported Department of Justice investigation, both of which are more fully described herein.

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PART I — FINANCIAL INFORMATION

Ra Medical Systems, Inc.

Condensed Balance Sheets

(Unaudited)

(in thousands, except share and per share data)

See notes to condensed financial statements.

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Ra Medical Systems, Inc.

Condensed Statements of Operations

(Unaudited)

(in thousands, except per share data)

See notes to condensed financial statements.

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Ra Medical Systems, Inc.

Condensed Statements of Comprehensive Loss

(Unaudited)

(in thousands, except per share data)

See notes to condensed financial statements.

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Ra Medical Systems, Inc.

Condensed Statements of Cash Flows

(Unaudited)

(in thousands)

See notes to condensed financial statements.

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Ra Medical Systems, Inc.

Condensed Statements of Stockholders’ Equity  

(Unaudited)

(in thousands)

See notes to condensed financial statements.

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Ra Medical Systems, Inc.

Notes to Condensed Financial Statements

(Unaudited)

Note 1—Organization and Nature of Operations

Ra Medical Systems, Inc. (the “Company”) was formed in September 4, 2002, in the state of California and reincorporated in Delaware on July 14, 2018. The Company is a medical device company that develops, manufactures and markets advanced excimer lasers for use in the treatment of vascular and dermatological diseases. The Company’s product development centers around proprietary applications of its advanced excimer laser technology for use as a tool in the treatment of peripheral artery disease (“PAD”) and psoriasis, vitiligo, atopic dermatitis and leukoderma.

Reincorporation—In July 2018, the Company reincorporated in Delaware, the par value of each share of common stock was established to be $0.0001 and the number of authorized shares of common stock was increased from 10,000,000 to 25,000,000. In connection with the reincorporation, common stock and additional paid-in capital amounts in these financial statements have been adjusted to reflect the par value of common stock. All share information included in these financial statements has been adjusted to reflect this reincorporation.

Initial Public Offering—On October 1, 2018, the Company closed its initial public offering ("IPO") of 4,485,000 shares of common stock at an offering price to the public of $17.00 per share, resulting in gross proceeds of approximately $76.2 million. These amounts include the exercise in full by the underwriters of their option to purchase 585,000 additional shares of common stock at the same price to the public to cover over-allotments. The aggregate net proceeds to the Company from its IPO were $67.3 million after deducting the underwriters discount and offering costs of $5.3 million and $3.6 million, respectively. The Company’s registration statement on Form S-1 relating to its IPO was declared effective by the Securities and Exchange Commission on September 26, 2018.

In connection with the IPO, the Company filed an Amended and Restated Certificate of Incorporation which authorizes the issuance of 300,000,000 shares of common stock with a par value of $0.0001 and 10,000,000 shares of preferred stock with a par value of $0.0001.

Liquidity — The Company believes that its cash and cash equivalents and short-term investments as of the date of these financial statements will be sufficient to fund its operations for at least the next 12 months. The Company continuously monitors and reevaluates its liquidity needs. Certain future events may occur that are outside the Company’s control which could negatively impact the Company’s cash position. These events may cause the Company to undertake additional cost savings measures or seek additional sources of financing.

Note 2—Significant Accounting Policies

Interim condensed financial information—The unaudited interim condensed financial statements have been prepared on the same basis as the annual financial statements and reflect all adjustments of a normal and recurring nature that are necessary for the fair presentation of the Company’s condensed balance sheets, results of operations, cash flows and statement of stockholders’ equity for the periods presented. The results of operations for the three and six months ended June 30, 2019 are not necessarily indicative of the results to be expected for the year ending December 31, 2019 or for any other future annual or interim period. The balance sheet as of December 31, 2018 included herein was derived from the audited financial statements as of that date. These unaudited condensed financial statements should be read in conjunction with the Company’s audited financial statements included in the Company’s Annual Report on Form 10-K filed with the SEC on March 15, 2019.

Use of estimates—The financial statements of the Company have been prepared by management in accordance with accounting principles generally accepted in the United States of America. The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and reported disclosures of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. The Company’s financial statements are based upon a number of estimates, including but not limited to, allowance for doubtful accounts, reserves for warranty costs including product recalls, evaluation of probable loss contingencies, fair value of stock option awards granted and revenue recognition for multiple performance obligations.

Short-term Investments—Investments with original maturities of greater than three months are classified as short-term investments. Debt investments are classified as available-for-sale and realized gains and losses are recorded using the specific identification method. Changes in fair value, excluding other-than-temporary impairments, are recorded in other comprehensive income (“OCI”). Debt investments are impaired when a decline in fair value is judged to be other-than-temporary. Fair value is calculated based on publicly available market information or other estimates determined by management. The Company employs a systematic methodology on a quarterly basis that considers available quantitative and qualitative evidence in

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evaluating potential impairment of our investments. If the cost of an investment exceeds its fair value, the Company evaluates, among other factors, general market conditions, credit quality of debt instrument issuers, and the duration and extent to which the fair value is less than cost. The Company also evaluates whether it has plans to sell the security or it is more likely than not that the Company will be required to sell the security before recovery. In addition, the Company considers specific adverse conditions related to the financial health of and business outlook for the investee, including industry and sector performance, changes in technology, and operational and financing cash flow factors. Once a decline in fair value is determined to be other-than-temporary, an impairment charge is recorded in other income (expense), net and a new cost basis in the investment is established.

Fair value measurements—Fair value represents the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants and is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. A three-tier value hierarchy is used to identify inputs used in measuring fair value as follows:

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

Level 2—Inputs other than the quoted prices in active markets that are observable either directly or indirectly in the marketplace for identical or similar assets and liabilities; and

Level 3—Unobservable inputs that are supported by little or no market data, which require the Company to develop its own assumptions.

The hierarchy requires the Company to use observable market data, when available, and to minimize the use of unobservable inputs when determining fair value.

The Company measures its cash equivalents and short-term investments at fair value.

Inventories—Inventories are stated at the lower of cost (first-in, first-out method) or net realizable value. Cost includes materials, labor and manufacturing overhead related to the purchase and production of inventories. The Company reduces the carrying value of inventories for those items that are potentially excess, obsolete or slow-moving based on changes in customer demand, technological developments or other economic factors.

Catheters are manufactured in-house and each catheter is tested at various stages of the manufacturing process for adherence to quality standards. Catheters that do not meet functionality specification at each test point are destroyed and immediately written off, with the expense recorded in cost of revenue in the statement of operations. Once manufactured, completed catheters that pass quality assurance, are sent to a third-party for sterilization and sealed in a sterile container. Upon return from the third-party sterilizer, a sample of catheters from each batch are re-tested. If the sample tests are successful, the batch is accepted into finished goods inventory and if the sample tests are unsuccessful, the entire batch is written off, with the expense recorded in cost of revenue in the statement of operations.

Revenue— The Company adopted ASC Topic 606 (Topic 606), Revenue from Contracts with Customers, on January 1, 2019 using the modified retrospective method to all contract agreements not completed as of January 1, 2019. Results for reporting periods beginning after January 1, 2019 are presented under Topic 606 while, as permitted by Topic 606, prior period amounts are not adjusted and continue to be reported under the accounting standards in effect for the prior period. The Company recorded a cumulative catch up adjustment to beginning accumulated deficit to reflect the impact of adopting Topic 606. The adoption of Topic 606 did not have a material effect on our results of operations for the three and six month periods ended June 30, 2019.

The Company generates revenue from the sale of products and services. Product sales consist of the sale of DABRA and Pharos laser systems, the sale of catheters for use with the DABRA laser, and the sale of consumables and replacement parts. The Company’s sales agreements generally do not include right-of-return provisions for any form of consideration including partial refund or credit against amounts owed to the Company. Services and other revenue primarily consist of sales of extended warranty and billable services, including repair activity and income from rental of lasers.

The Company determines revenue recognition incorporating the following steps:

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The Company accounts for a contract with a customer when it has a legally enforceable contract with the customer, the arrangement identifies the rights of the parties, the contract has commercial substance, and the Company determines it is probable that it will collect the contract consideration. The Company recognizes revenue when control of the promised goods or services transfers to customers, in an amount that reflects the consideration the Company expects to be entitled to in exchange for those goods or services. Taxes collected from customers relating to goods or services and remitted to governmental authorities are excluded from revenue.

Catheter Revenue

The Company enters into a DABRA laser commercial usage agreement or DABRA laser placement acknowledgement with each customer that is supplied a DABRA laser, collectively the “usage agreement”. The usage agreement provides for specific terms of continued use of DABRA laser, including a nominal periodic fee. The terms of a usage agreement typically allow the Company to place a DABRA laser at a customer’s specified location without a specified contract term. Under the usage agreement terms, the Company retains all ownership rights to the DABRA laser and is allowed to request the return of the equipment within 10 business days of notification. While the laser periodic fees are nominal, the laser usage agreements provide the Company the exclusive rights to supply related single-use catheters to the customer which aggregate the majority of the vascular segment revenue. There are no specified minimum purchase commitments for the catheters.

The Company recognizes revenue associated with the usage agreement and catheter supply arrangements in accordance with Topic 606 as the contract primarily includes variable payments, the catheters are priced at their standalone selling price and the equipment is insignificant in the context of the contract. Revenue is recognized when the performance obligation is satisfied, which is generally upon shipment of the catheter.  

Laser Sales

Laser sales consist of sales of DABRA and Pharos laser systems and are included in product sales in the statement of operations. The Company recognizes revenue on laser sales at the point in time that control transfers to the customer. Control of the product typically transfers upon shipment.

Warranty Service Revenue

The Company typically provides a 12-month warranty with the purchase of its laser systems. Customers can extend the warranty period through the purchase of extended warranty service contracts. Extended warranty service contracts are sold with contract terms ranging from 12 to 60 months and cover periods after the end of the initial 12-month warranty period. The warranty provides the customer with maintenance services in addition to the assurance that the laser product complies with agreed-upon specifications. Therefore, the warranty service is treated as a separate performance obligation from the laser system. Warranty services are a stand-ready obligation, and the Company recognizes revenue on a straight-line basis over the service contract term. Warranty service revenue is included in service and other revenue in the Statement of operations. Deferred revenue after adoption of Topic 606 on January 1, 2019 was $2.8 million. Revenue recognized in the three and six months ended June 30, 2019 relating to amounts previously included in deferred revenue was $0.6 million and $1.2 million, respectively. The deferred revenue greater than one year will be recognized during the remaining service period through June 2024.

Distributor Transactions

In certain markets outside the U.S., the Company sells products and provides services to customers through distributors that specialize in medical device products. The terms of sales transactions through distributors are generally consistent with the terms of direct sales to customers. The Company accounts for these transactions in accordance with the Company’s revenue recognition policy described herein.

Contracts with multiple performance obligations

Certain of the Company’s contracts with customers contain multiple performance obligations. For these contracts, the Company accounts for individual products and services as separate performance obligations if they are distinct, which is if (i) a product or service is separately identifiable from other items in the arrangement and (ii) the customer can benefit from the product or service on its own or with other readily available resources. The transaction price is allocated to the separate performance obligations on a relative standalone selling price basis. The Company determines standalone selling prices based on observable prices of products or services sold separately in comparable circumstances to similar customers.

Significant Financing Component

For multi-year warranty service contracts in which there is a difference between the cash selling price and the consideration in the contract and a significant amount of time between the payment, which is due up-front, and delivery of the services (greater than one year), the Company records an adjustment for significant financing to reflect the time value of money. The Company recognizes revenue associated with the cash selling price and interest expense using the effective interest method as the Company satisfies its performance obligation(s). The amount of interest expense the Company recognizes over the contract term is based on the contract liability balance, which increases for the accrual of interest and decreases as services are provided.

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For services contracts that have an original duration of one year or less, the Company uses the practical expedient applicable to such contracts and does not adjust the transaction price for the time value of money.

Practical expedients elected

As part of the Company’s adoption of Topic 606, the Company elected to use the following practical expedients:

Contract Costs

The Company capitalizes costs to obtain contracts that are considered incremental and recoverable, such as sales commissions. The capitalized costs are amortized to selling, general and administrative expense over the estimated period of benefit of the asset, which is the contract term. The Company elected to use the practical expedient to expense the costs to obtain a contract when the amortization period is less than one year. The Company has contract costs of $0.4 million capitalized at January 1, 2019 and June 30, 2019.

Rental Income

The Company also adopted ASC Topic 842, Leases, on January 1, 2019 using the optional transitional method. There was no adjustment to accumulated deficit at January 1, 2019.  

The Company also derives income pursuant to product lease agreements for its Pharos laser systems, as operating leases. Consequently, the Company retains title to the equipment and the equipment remains on Company’s balance sheet within property and equipment. Depreciation expense on these leased lasers is recorded to cost of revenues on a straight-line basis. The costs to maintain these leased lasers are charged to cost of revenues as incurred.

These lease arrangements contain one lease component (the laser) and one nonlease component (warranty service) for which the Company elected the practical expedient to not separate the nonlease component from the lease component. The Company accounts for the combined lease component as an operating lease and recognizes lease income on a straight-line basis over the lease term. Rental income from lease arrangements for the three and six months ended June 30, 2019 was $0.2 million and $0.3 million, respectively. Rental income from lease arrangements for the three and six months ended June 30, 2018 was $0.1 million and $0.2 million, respectively.

Product warranty—The Company records estimated product warranty costs at the time of sale. Products are warrantied against defects in material and workmanship when properly used for their intended purpose and appropriately maintained. Accordingly, the Company generally replaces catheters that kink or fail to calibrate. The product warranty liability is determined based on historical information such as past experience, product failure rates or number of units repaired, estimated cost of material and labor. The product warranty liability also includes the estimated costs of a product recall. In September 2019, the Company initiated a voluntary recall of its DABRA laser system single-use catheters due to a change in product labeling.

Product warranties are included for the first year after the sale for laser sales. For lasers, the customer may purchase an extended service contract, which is either negotiated in the contract or sold as a separate component for which revenue is recognized over the term of the agreement.

The warranty accrual is included in accrued expenses in the accompanying balance sheets. Warranty expenses are included in cost of revenue in the accompanying statements of operations. Changes in estimates to previously established warranty accruals result from current period updates to assumptions regarding repair and product recall costs and are included in current period warranty expense.

Recently Issued Accounting Pronouncements— In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 expands the scope of Topic 718, Compensation—Stock Compensation, to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees. The amendments are effective for fiscal years beginning after December 15, 2019. Early adoption is permitted, but no earlier than a company’s adoption date of Topic 606, Revenue from Contracts with Customers. The Company is evaluating the effect that this guidance will have on the financial statements and related disclosures.

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In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) - Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement, which is designed to improve the effectiveness of disclosures by removing, modifying and adding disclosures related to fair value measurements. ASU No. 2018-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years, and the ASU allows for early adoption in any interim period after issuance of the update. The adoption of this ASU is not expected to have a significant impact on the Company’s financial statements.

In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments - Credit Losses (Topic 326), to require the measurement of expected credit losses for financial instruments held at the reporting date based on historical experience, current conditions and reasonable forecasts and applies to all financial assets, including trade receivables. The main objective of this ASU is to provide financial statement users with more decision-useful information about the expected credit losses on financial instruments and other commitments to extend credit held by a reporting entity at each reporting date. ASU No. 2016-13 is effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company is currently assessing the impact this ASU will have on its financial statements and related disclosures.

Recently Adopted Accounting Pronouncements—On April 5, 2012, President Obama signed the Jump-Start Our Business Startups Act (the “JOBS Act”) into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an emerging growth company. As an emerging growth company, the Company may elect to adopt new or revised accounting standards when they become effective for non-public companies, which typically is later than public companies must adopt the standards. The Company has elected to take advantage of the extended transition period afforded by the JOBS Act and, as a result, will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-public companies, which are the dates included below.

In May 2014, FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), and issued subsequent amendments to the initial guidance in August 2015, March 2016, April 2016 and May 2016 within ASU 2015-14, ASU 2016-08, ASU 2016-10 and ASU 2016-12, respectively. ASU 2014-09 supersedes nearly all existing revenue recognition guidance under generally accepted accounting principles in the United States (“US GAAP”). The core principle of ASU 2014-09 is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that the Company expects to receive for those goods or services. The Company adopted this accounting standard in the first quarter of fiscal year 2019 using the modified retrospective method. The Company recorded an adjustment to accumulated deficit in the first quarter of 2019 for the following items; (i) differences in the amount of revenue recognized for the Company’s revenue streams as a result of allocating revenue based on standalone selling prices to the Company’s various performance obligations, (ii) capitalization of incremental contract acquisition costs, such as sales commissions paid in connection with product sales with multi-year service contracts, which will be amortized over the contract service period and (iii) recognized a significant financing component for multi-year service contracts for customers who pay more than one year in advance of receiving the service. The Company recognized the significant financing component over the contract service period. The Company recorded a $21,000 reduction to accumulated deficit as a result of the adoption of Topic 606.

In February 2016, FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). This update requires lessees to recognize, on the balance sheet, a lease liability and a lease asset for all leases with a term greater than 12 months, including operating leases. The update also expands the required quantitative and qualitative disclosures surrounding leases. Under the new standard, the Company will have to recognize, on the balance sheet, a liability representing its lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term. ASU 2016-02 is effective for the Company beginning January 1, 2020, with early adoption permitted. Lessor accounting under ASU 2016-02 is similar to the current model but updated to align with certain changes to the lessee model. Lessors will continue to classify leases as operating, direct financing or sales-type leases. In addition, the new standard requires that lease and nonlease components of a contract be bifurcated, with nonlease components subject to the new revenue recognition standard effective upon adoption of the new leasing standard. Lessors are allowed to elect to account for the lease and nonlease components as a single combined lease component if (i) the timing and pattern of the revenue recognition is the same, and (ii) the combined lease component would continue to be classified as an operating lease.

The Company adopted the standard using the optional transition method provided by ASC Update No. 2018-11, Leases (Topic 842): Targeted Improvements. Under this method, the Company applied the new leasing rules on January 1, 2019. As part of the adoption, the Company elected the package of practical expedients permitted under the new lease standard, which among other things, allowed the Company to carry forward the historical lease classification. The Company also elected the practical expedient to combine lease and non-lease components. The Company recognized right-of-use assets and lease liabilities of $3.2 million upon adoption of ASU 2016-02. The new lease standard did not change the Company’s accounting for leases in which the Company is the lessor.

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Note 3—Short-term Investments

A summary of debt securities by major security type is as follows as of June 30, 2019:

All debt securities are due in less than one year.

The following table presents the hierarchy for assets measured at fair value on a recurring basis as of June 30, 2019 and December 31, 2018 (in thousands):

Note 4—Inventories

Inventories consisted of the following (in thousands):

Note 5—Property and Equipment, net

Property and equipment consisted of the following (in thousands):

Depreciation expense was $0.4 million and $0.1 million for the three months ended June 30, 2019 and 2018, respectively and $0.7 million and $0.2 million for the six months ended June 30, 2019 and 2018, respectively.  

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Note 6—Accrued Expenses

Accrued expenses consisted of the following (in thousands):

Note 7—Accrued Warranty

Activity in the product warranty accrual is included in accrued expenses above and consists of the following (in thousands):

Warranty expense was $0.5 million and nil for the three months ended June 30, 2019 and 2018, respectively, and $0.8 million and $0.1 million for the six months ended June 30, 2019 and 2018, respectively. The three and six month periods ended June 30, 2019 includes $0.2 million relating to the recall of catheters. Warranty expense is included in cost of revenue in the accompanying condensed statements of operations.

Note 8—Leases

The Company recognized non-cash right-of-use assets and lease liabilities of $3.2 million upon adoption of ASU 2016-02 on January 1, 2019. The Company has two operating leases for office and manufacturing space which requires it to pay base rent and certain utilities. Monthly rent expense is recognized on a straight-line basis over the term of the leases, which expire in 2027 and 2021.

At June 30, 2019 the weighted average remaining lease term was eight years. The operating leases are included in the balance sheet at the present value of the lease payments at a 7% discount rate using the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term and amount equal to the lease payments in a similar economic environment as the leases do not provide an implicit rate.

For the three and six months ended June 30, 2019, operating lease expense was $0.1 million and $0.3 million, respectively. For the three and six months ended June 30, 2019, cash paid was $0.1 million and $0.2 million, respectively. Rent expense was $0.1 million and $0.2 million for the three and six months ended June 30, 2018, respectively. Operating lease right-of-use assets amortization was $0.1 million and $0.2 million for the three and six months ended June 30, 2019, respectively. Variable costs are de minimis.

The following table presents the lease liabilities within the condensed balance sheet, related to the Company’s operating leases as of June 30, 2019 (in thousands):

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The following table presents the future minimum rental payments due as of December 31, 2018 (in thousands):

Note 9—Loss per Share

The Company calculates basic loss per share by dividing net loss by the weighted average number of common shares outstanding during the reporting period. Diluted loss per share would reflect the effects of potentially dilutive securities, if any.

Anti-dilutive common share equivalents excluded from the computation of diluted net loss per share at June 30, 2019 consisted of stock options of 1,892,200, restricted stock units of 1,237,895 and Employee Stock Purchase Plan shares of 30,046. At June 30, 2018 basic and diluted loss per share were the same.  

Note 10—Stock-Based Compensation

In 2003, the Company adopted a stock option plan (the “2003 Plan”), which authorized the board of directors to grant stock option awards to eligible employees, directors, consultants and service providers (together the “Optionees”) of the Company. In April 2012, such plan expired. In 2014, the Company established the 2014 Stock Option Plan (the “2014 Plan”) whereby 1,000,000 shares of the Company’s common stock were reserved for issuance to eligible Optionees. The 2014 Plan provided for the grant of incentive stock options, non-statutory stock options, stock bonuses and rights to acquire restricted stock. Option awards under the 2014 Plan expired up to a maximum of 10 years from the date of the grant. On May 17, 2018, the Company’s board of directors terminated the 2014 Plan.

Obligations under the 2003 Plan and 2014 Plan included time and performance-based awards. For time-based awards, vesting generally occurred over the service period of up to four years. Performance based awards vested at the time that the underlying performance conditions were met.

In prior years, the Company concluded that option awards communicated to Optionees (the “Communicated Option Awards”) under the 2003 Plan and 2014 Plan were not validly authorized and therefore were not valid outstanding option awards. Although the Communicated Option Awards were not outstanding options, the Company believed the Communicated Option Awards represented a contractual obligation to the Optionees and therefore the Company classified the Communicated Option Awards as liabilities in the financial statements which were remeasured at fair value each reporting period.

On June 4, 2018, the 2014 Plan was replaced with the 2018 Stock Compensation Plan (the “Compensation Plan”) whereby 3,300,000 shares of the Company’s common stock were reserved for issuance. On June 4, 2018, the Company’s board of directors authorized 1,901,900 replacement equity awards of stock options and, on June 8, 2018, 1,340,832 restricted stock units (collectively, the “Replacement Awards”) to the Optionees. On various dates in June 2018, but after the board of directors’ authorization, the Replacement Awards were communicated to the Optionees in exchange for the cancellation of, and waiver to any claims related to, the Communicated Option Awards granted under the 2003 Plan and 2014 Plan which were determined to be not validly authorized. The issuance of the Replacement Awards and cancellation of the Communicated Option Awards was treated as a modification. The modification date is the date of the grant of the Replacement Awards, such date being June 4, 2018 for options and June 8, 2018 for restricted stock unit awards. The Company is recognizing the remaining unrecognized compensation cost, as well as any incremental compensation cost of the Replacement Awards of $17.2 million, over the remaining service period of the Replacement Awards, as described below. As the Replacement Awards have been determined to be equity-classified awards, the Company no longer records such awards as liabilities. The Compensation Plan terminated in connection with the adoption of the Company’s 2018 Equity Incentive Plan, described below, and, accordingly no new awards are available for issuance under this plan. The Compensation Plan continues to govern awards granted thereunder.

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Stock options granted under the Compensation Plan, including those granted as a component of the Replacement Awards, generally vest 33% on the first anniversary of the grant date with the balance vesting monthly over the remaining two years. The restricted stock units granted under the Compensation Plan, including those granted as a component of the Replacement Awards, include a service condition and a performance condition. The service condition generally begins on the grant date and continues through January 2020 and the restricted stock units vest at various times commencing March 27, 2019 until January 2020. The performance condition related to the Company completing its IPO and the vesting of the restricted stock units were contingent upon the achievement of such IPO, which was achieved on October 1, 2018.

In September 2018, the Company’s board of directors adopted, and the Company’s stockholders approved, the Company’s 2018 Equity Incentive Plan (the “2018 Plan”). The 2018 Plan became effective on September 25, 2018. As of June 30, 2019, 1,918,439 shares of common stock are reserved for future issuance pursuant to the Company’s 2018 Plan. In addition, the shares reserved for issuance under the 2018 Plan include (1) those shares reserved but unissued under the Compensation Plan as of the date of stockholder approval of the 2018 Plan and (2) shares of common stock subject to or issued pursuant to awards granted under the Compensation Plan that, after the date of stockholder approval of the 2018 Plan, expire or otherwise terminate without having been exercised in full or are forfeited to or repurchased by us (provided that the maximum number of shares that may be added to the 2018 Plan pursuant to (1) and (2) is 3,300,000 shares). The 2018 Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code to the Company’s employees and any of the Company’s parent and subsidiary corporations’ employees, if applicable, and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to the Company’s employees, directors and consultants and the Company’s parent and subsidiary corporations’ employees, if applicable, and consultants. The number of shares available for issuance under the Company’s 2018 Plan also includes an annual increase on the first day of each fiscal year beginning with our 2019 fiscal year, equal to the least of (1) 1,632,134 shares; (2) five percent (5%) of the outstanding shares of our common stock as of the last day of the immediately preceding fiscal year; or (3) such other amount as our board of directors may determine.

Stock options granted under the 2018 Plan generally vest 25% on the first anniversary of the vesting commencement date with the balance vesting monthly over the remaining three years. Restricted stock units granted under the 2018 plan generally have a vesting schedule with one third of the total number of shares underlying the restricted stock units vesting on the first anniversary of the vesting commencement date and one sixth of the total shares vesting every six months thereafter such that the award will be fully vested on the third anniversary of the vesting commencement date.

A summary of the activity and related information of the Communicated Option Awards classified as liabilities and communicated during the six months ended June 30, 2018, is presented below:

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A summary of the activity and related information of the stock options issued during the six months ended June 30, 2019 is presented below:

A summary of the activity and related information of the restricted stock units issued during the six months ended June 30, 2019 is presented below:

Stock-based compensation expense recorded in operating expenses was as follows (in thousands):

Stock-based compensation amounts of $0.5 million and $0.3 million were capitalized to inventory and property and equipment during the three months ended June 30, 2019 and 2018, respectively. Stock-based compensation of $1.0 million and $0.3 million were capitalized to inventory and property and equipment during the six months ended June 30, 2019 and 2018, respectively.

Unrecognized compensation expense for stock options issued as of June 30, 2019 was $11.0 million and is expected to be recognized over a weighted-average period of 1.9 years. Unrecognized compensation expense for the restricted stock units as of June 30, 2019 was $11.6 million and is expected to be recognized over a weighted-average period of 0.8 years.

The Communicated Option Awards were presented as a stock-based compensation liability, until June 4, 2018, when they were settled and reclassified to equity. The Communicated Option Awards were revalued at each reporting period with the change in fair value recorded to compensation expense.    

The fair value of the Communicated Option Awards was estimated using the Black Scholes option pricing model and the assumptions used in the model are noted in the following table:

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The weighted-average fair value for Communicated Option Awards granted during the three months ended June 30, 2018 was $14.32 and during the six months ended June 30, 2018 was $14.00. The Company’s shares were not traded on any public market during the term of the Communicated Option Awards. The common stock value as of the date of grant was based on the share price of recent equity issuances, if available. If there were no such recent transactions, the Company’s share valuation was estimated. As of the date of the modification of the Communication Option Awards, which resulted in the settlement of the stock-based compensation liability, the common stock price was estimated utilizing a hybrid method, a combination of the Probability Weighted Expected Return Method (“PWERM”) and Option Pricing Model (“OPM”). The estimate incorporated a near-term IPO scenario using PWERM weighted at 80%. Other near-term exit events, a long-term stay private case, and dissolution were all considered as non-IPO scenarios using OPM, and were weighted at 20%. The estimate also reflected a 10% and 15% discount for lack of marketability under PWERM and OPM, respectively. The risk free interest rate approximates the implied yield available on United States Treasury securities with an equivalent remaining term. Expected volatility is based on the historical volatilities of certain “guideline” companies. Expected dividend yield is based on dividends historically paid by the Company. The expected life is based on the “simplified” method using the average of the term and vesting period.

No stock options were issued under the 2018 Plan during the six months ended June 30, 2019.

The fair value of the stock options issued under the Compensation Plan was estimated using the Black Scholes option pricing model and the weighted-average assumptions used in the model are noted in the following table:

The Company’s 2018 Employee Stock Purchase Plan (ESPP) became effective in September 2018. A total of 446,160 shares of common stock are available for sale under our ESPP as of June 30, 2019. Under the Company’s ESPP, eligible employees are allowed to purchase the Company’s stock at a discounted price, which is 85% of the lower market price of the Company’s common stock at the beginning or at the end of the six-month purchase period. The Company issued 9,207 shares in exchange for $37,000 in the six months ended June 30, 2019 under the ESPP. The number of shares of common stock that will be available for sale under the ESPP also includes an annual increase on the first day of each fiscal year beginning with our 2019 fiscal year, equal to the least of (1) 296,752 shares; (2) one and one quarter percent (1.25%) of the outstanding shares of our common stock as of the last day of the immediately preceding fiscal year; or (3) such other amount as the administrator may determine.

Note 11—Commitments and Contingencies

Securities Litigation

On June 7, 2019, a putative securities class action complaint captioned Derr v. Ra Medical Systems, Inc., et. al., (Civil Action no. 19CV1079 LAB NLS) was filed in the United States District Court for the Southern District of California against the Company, certain current and former officers and directors, and certain underwriters of the Company’s IPO. The complaint alleges that the defendants made material misstatements or omissions in the Company’s registration statement that caused the stock price to drop. The court appointed a Lead Plaintiff on September 5, 2019, and on October 2, 2019, it ordered that Lead Plaintiff file an amended complaint within forty-five days after the Company files with the SEC its Form 10-Q for the period ended June 30, 2019. Management intends to vigorously defend the Company against this lawsuit. At this time, the Company cannot predict how a court or jury will rule on the merits of the claims and/or the scope of the potential loss in the event of an adverse outcome. Should the Company ultimately be found liable, the liability could have a material adverse effect on our financial condition and our results of operations for the period or periods in which it is incurred. The Company is unable to predict the ultimate outcome and is unable to make a meaningful estimate of the amount or range of loss, if any, that could result from any unfavorable outcome.

On October 1, 2019, a shareholder derivative complaint captioned Noel Borg v. Dean Irwin, et. al (Civil Action no. 1:99-cm-09999) was filed in the United States District Court for the District of Delaware against certain current and former officers and directors, purportedly on behalf of the Company, which is named as a nominal defendant in the action. The complaint alleges breaches of fiduciary duty, unjust enrichment, waste, and violations of Section 14(a) of the Securities Exchange Act of 1934. On October 21, 2019, pursuant to the parties’ stipulation, the court stayed the derivative lawsuit until the related class action is resolved.

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Governmental Investigations

As previously announced in the Form 8-K filed on August 12, 2019, the Audit Committee of Ra Medical’s Board of Directors (the “Audit Committee”) was conducting an investigation of certain allegations raised by a former employee. The Company announced the Audit Committee’s findings in the Form 8-K filed on October 31, 2019. The primary investigative findings were: (i) the DABRA catheter frequently failed to calibrate and occasionally overheated, posing a risk of injury to physicians and patients; (ii) our explanations regarding our fourth quarter 2018 and first quarter 2019 sales created a risk of confusion because they did not explicitly reference inconsistent DABRA catheter performance and catheter failures; (iii) we failed to timely make at least two Medical Device Reports, or MDRs, to the FDA; (iv) we, out of a concern for the DABRA catheters’ performance, engaged in systematic efforts to replace product held by customers, which constituted product recalls, but were not documented as such, (v) we lack documentation of sufficient detail and specificity to support certain payments to physicians, ostensibly for training and consulting services, and as to three physicians did not accurately reflect the purpose and nature of approximately $300,000 of payments, which could be perceived as an improper attempt to obtain business or to gain special advantage, (vi) while the indication for use in the 510(k) clearance we obtained for the DABRA system is not for atherectomy, our salespeople were instructed to characterize DABRA as performing atherectomy and to encourage doctors to seek reimbursement using atherectomy codes, (vii) our determinations to direct potentially valuable benefits and opportunities to doctors were informed in part by sales prospects, and (viii) we received complaints regarding regulatory or compliance concerns that, because they implicated executive officers, should have been brought to the attention of the Board or the Audit Committee, but were not. The Audit Committee, in reviewing the allegations, identified certain behavior inconsistent with our Code of Ethics and Conduct and related policies.

As also previously announced, the Company voluntarily contacted the SEC’s Enforcement Division regarding the Audit Committee’s investigation and remains in discussion with such Agency.

In October 2019, the Department of Justice, or DOJ, served the Company with a Civil Investigative Demand seeking information with respect to a False Claims Act investigation concerning whether the Company fraudulently obtained 510(k) marketing clearance for the Company’s devices marketed under the trade name DABRA, whether the Company marketed and promoted DABRA devices for unapproved uses that were not covered by federal healthcare programs, and whether the Company paid improper remuneration to physicians and other healthcare providers in violation of the Anti-Kickback Statute, 42 U.S.C. §1320a-7b. In response to the DOJ’s CID, the Company reviewed the facts and circumstances of the clinical study used to support its 510(k) marketing clearance and has now completed such review. Following this review, the Company believes there is (i) adequate evidence to support the safety and efficacy reported in the study submitted with the 510(k) application, and (ii) no observations that would have a major impact on the reported results of the study. The Company is cooperating fully with the DOJ’s request in connection with the Civil Investigative Demand. The Company is unable to predict the ultimate outcome and is unable to make a meaningful estimate of the amount or range of loss, if any, that could result from any unfavorable outcome.

The Company received a letter on November 13, 2019, from the Los Angeles Office of the Division of Enforcement of the Securities and Exchange Commission (the “SEC”), in which the SEC notified the Company that it is conducting an investigation. The Company has been, and intends to continue, cooperating with the SEC in this investigation.  The Company is unable to predict the ultimate outcome and is unable to make a meaningful estimate of the amount or range of loss, if any, that could result from any unfavorable outcome.

On November 21, 2019, we became aware that the Criminal Division, Fraud Section of the U.S. Department of Justice has an open investigation related to the Company.  At this time, it is unclear if the Company is a target in this investigation.  The Company intends to cooperate with the DOJ criminal investigation.

Other Litigation

On August 30, 2018, Strata Skin Sciences, Inc. (“Strata”) and Uri Geiger, a member of the board of directors of Strata Skin Sciences, Inc. filed an action against the Company in Pennsylvania State Court, Montgomery County (Civil Action No. 18-21421) (the “Pennsylvania Case”), requesting declaratory relief that: (1) Strata and Mr. Geiger are not liable for tortious interference, defamation, libel, or unfair competition based on an e-mail by Mr. Geiger to an investment bank (the “Geiger Email”); (2) Strata and Mr. Geiger made no actionable statements about the Company to such investment bank; (3) the Company cannot enforce the 2011 settlement and release agreement between the Company and PhotoMedex, Inc. (“Settlement Agreement”) against Strata; and (4) that any dispute regarding the Geiger Email does not relate to the Settlement Agreement. The action filed by Strata and Mr. Geiger does not request any monetary damages. The Company believes that the action by Strata and Mr. Geiger was filed as a response to a letter that the Company sent to Strata on August 22, 2018 demanding that Strata and Mr. Geiger cease and desist from making statements about alleged patent infringement and affirmatively retract the statements made in the Geiger Email. The Company was served with the action on August 31, 2018, and responded with preliminary objections to the action on September 19, 2018. The court overruled the Company’s preliminary arguments on April 29, 2019. The Company filed a motion for summary judgment on July 17, 2019 for the court to rule that the Company can enforce the Settlement Agreement against Strata. The Company believes that Strata’s action in the Pennsylvania Case lacks merit, and plans to vigorously oppose the action on procedural and substantive grounds within the prescribed time limits. No loss is probable or reasonably possible as of June 30, 2019.

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On May 16, 2019, the Company filed an action against Strata, Mr. Geiger and Accelmed Growth Partners, L.P. and its affiliates (collectively, the “Strata Parties”) in the United States District Court for the Southern District of California (Civil Action No. 19-cv-0920-AJB-MSB (the “California Case”)) alleging (1) violation of the Settlement Agreement, (2) tortious interference with economic advantage, and (3) trade libel based on the Geiger Email. In the lawsuit, the Company alleges, among other things, that the statements in the Geiger Email regarding alleged patent infringement constitute a breach of the Settlement Agreement, that the Strata Parties employed deceptive practices designed to delay the Company’s initial public offering and reduce the amount of capital raised by the Company, and that statements in the Geiger Email regarding patent infringement, off label promotion and reimbursement constitute trade libel. The Company seeks an injunction barring the Strata Parties’ alleged conduct, monetary damages, and other available legal and equitable relief. The Company amended its complaint on July 25, 2019 to allege violations of the Lanham Act’s prohibition on false advertising. The Strata Parties filed motions to dismiss on August 25, 2019, and the Company responded with its oppositions to the motions to discuss on September 27, 2019. The Court has set a hearing date of December 19, 2019 on the motions to dismiss.

Note 12—Segment Information

The Company has organized its business into two operating segments based on the product specialties: the vascular segment and the dermatology segment.

In deciding how to allocate resources and assess performance, the Company’s chief operating decision maker regularly evaluates the sales and gross profit of these segments. Amounts included within selling, general and administrative expense and research and development expense are general to the Company and not specific to a particular segment; therefore, these amounts are not evaluated by the Company’s chief operating decision maker on a segmented basis.

The following tables summarize segment performance (in thousands):

Generally, all assets are common assets, except for lasers placed with customers, which are a subset of property and equipment. The net book value of demonstration lasers and lasers placed with customers aggregated in the vascular segment was $2.9 million and $2.2 million as of June 30, 2019 and December 31, 2018, respectively. The net book value of the demonstration lasers and lasers placed with customers aggregated in the dermatology segment was $0.9 million and $0.7 million as of June 30, 2019 and December 31, 2018, respectively.

No sales to an individual customer or country other than the United States accounted for more than 10% of net revenue for the three and six months ended June 30, 2019 and 2018. Net revenue, classified by the major geographic areas in which our customers are located, was as follows (in thousands):

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Special Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available. This section should be read in conjunction with our unaudited condensed financial statements and related notes included in Part I, Item 1 of this report. The statements contained in this Quarterly Report on Form 10-Q that are not historical facts are 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.

Forward-looking statements can be identified by words such as “believe,” “anticipate,” “may,” “might,” “can,” “could,” “continue,” “depends,” “expect,” “expand,” “forecast,” “intend,” “predict,” “plan,” “rely,” “should,” “will,” “may,” “seek,” or the negative of these terms or and other similar expressions, although not all forward-looking statements contain these words. You should read these statements carefully because they discuss future expectations, contain projections of future results of operations or financial condition, or state other “forward-looking” information. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements.

These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including, but not limited to, those described in “Risk Factors”. These forward-looking statements reflect our beliefs and views with respect to future events and are based on estimates and assumptions as of the date of this Quarterly Report on Form 10-Q and are subject to risks and uncertainties. We discuss many of these risks in greater detail in the section entitled “Risk Factors” included in Part II, Item 1A and elsewhere in this report. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We qualify all of the forward-looking statements in this Quarterly Report on Form 10-Q by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, whether as a result of new information, future events or otherwise.

This Quarterly Report on Form 10-Q also contains estimates, projections and other information concerning our industry, our business, and the markets for certain diseases, including data regarding the estimated size of those markets. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events and circumstances reflected in this information. Unless otherwise expressly stated, we obtained this industry, business, market, and other data from reports, research surveys, studies, and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data, and similar sources.

Filing Delay; Audit Committee Investigation

The filing of this quarterly report on Form 10-Q was delayed allowing the Audit Committee of our board of directors to conduct an investigation related to an initially anonymous complaint, as well as additional matters discovered during the course of the investigation. As a result of the findings from the investigation as described below, it was determined that that no adjustments to past financial statements were appropriate or required. With the filing of this report along with our Quarterly Report on Form 10-Q for the third quarter ended September 30, 2019 we are current with our SEC filing obligations.

The Audit Committee’s primary investigative findings were: (i) the DABRA catheter frequently failed to calibrate and occasionally overheated, posing a risk of injury to physicians and patients; (ii) our explanations regarding our fourth quarter 2018 and first quarter 2019 sales created a risk of confusion because they did not explicitly reference inconsistent DABRA catheter performance and catheter failures; (iii) we failed to timely make at least two Medical Device Reports, or MDRs, to the FDA; (iv) we, out of a concern for the DABRA catheters’ performance, engaged in systematic efforts to replace product held by customers, which constituted product recalls, but were not documented as such, (v) we lack documentation of sufficient detail and specificity to support certain payments to physicians, ostensibly for training and consulting services, and as to three physicians did not accurately reflect the purpose and nature of approximately $300,000 of payments, which could be perceived as an improper attempt to obtain business or to gain special advantage, (vi) while the indication for use in the 510(k) clearance we obtained for the DABRA system is not for atherectomy, our salespeople were instructed to characterize DABRA as performing atherectomy and to encourage doctors to seek reimbursement using atherectomy codes, (vii) our determinations to direct potentially valuable benefits and opportunities to doctors were informed in part by sales prospects, and (viii) we received complaints regarding regulatory or compliance concerns that, because they implicated executive officers, should have been brought to the attention of the Board or the Audit Committee, but were not.

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The Audit Committee, in reviewing the allegations, identified certain behavior inconsistent with our Code of Ethics and Conduct and related policies involving certain of our former executive officers and employees. This resulted in material weaknesses in our control environment – see Item 4. Controls and Procedures for more detail.

The Audit Committee made a number of recommendations which the board of directors has adopted, including: separation of certain former executives and employees, implementing additional and enhanced policies and training, strengthening our quality regulatory systems, and adopting certain enhanced controls related to the matters investigated.

In addition, we have continued to take steps in an effort to remedy the inconsistencies in the Company’s DABRA catheter performance, including hiring a VP, Quality, Regulatory and Clinical, conducting extensive internal and external audits of its quality systems, clinical trial data and manufacturing process, as well as initiating the previously announced voluntary recall of DABRA catheters.

The Company voluntarily contacted the SEC’s Enforcement Division regarding the Audit Committee’s investigation and learned on November 13, 2019 that the SEC is conducting an investigation . The Company intends to cooperate with the SEC’s investigation. As previously reported, in October 2019, the Department of Justice (“DOJ”) provided the Company with a Civil Investigative Demand (“CID”) seeking information with respect to a False Claims Act investigation concerning, among other items, whether the Company fraudulently obtained 510(k) marketing clearance for its ablation devices marketed under the trade name DABRA (an item that had not been investigated by the Audit Committee). The Company intends to cooperate with the DOJ’s civil investigation. In response to the DOJ’s CID, the Company reviewed the facts and circumstances of the clinical study used to support its 510(k) marketing clearance and has now completed such review. Following this review, the Company believes there is (i) adequate evidence to support the safety and efficacy reported in the study submitted with the 510(k) application, and (ii) no observations that would have a major impact on the reported results of the study.

In November 2019, the Company also learned that the DOJ is conducting a criminal investigation. At this time, it is unclear if the Company is a target in this investigation. The Company intends to cooperate with the DOJ’s criminal investigation.

Overview

We are a commercial-stage medical device company leveraging our advanced excimer laser-based platform for use in the treatment of vascular and dermatological immune-mediated inflammatory diseases. We believe our products enhance patients’ quality of life by restoring blood-flow in arteries and clearing chronic skin conditions. Following the evaluation period for DABRA and once our customers decide to continue using DABRA in their facilities, we typically enter into DABRA laser commercial usage agreements or DABRA laser placement acknowledgements with each customer, which we refer to collectively as Usage Agreements. The terms of the Usage Agreements vary by customer, but each Usage Agreement provides for the specific terms of continued use of DABRA, including periodic maintenance fees and do not provide for a minimum purchase obligation. As of June 30, 2019, we had 83 lasers at customer sites under signed Usage Agreements with varying volumes of purchases.

DABRA is cleared by the U.S. Food and Drug Administration, or FDA, as a device for crossing chronic total occlusions, or CTOs, in patients with symptomatic infrainguinal lower extremity vascular disease and with an intended use for ablating a channel in occlusive peripheral vascular disease. DABRA is used as a tool in the treatment of peripheral artery disease, or PAD, a form of peripheral vascular disease, which commonly occurs in the legs. These procedures are typically referred to in the medical community as atherectomy procedures, which the medical community commonly defines as any removal by surgery or specialized catheterization of an atheroma, or blockage, in an artery. Even though the medical community refers to it as atherectomy, DABRA is not currently cleared by the FDA for atherectomy. Nevertheless, third-party health payers can reimburse a procedure performed by a device which is not cleared or approved for a specific indication or procedure, if the physician determines the device and procedure are medically appropriate for a particular patient. Payers and the medical community can take a broader view than FDA in recognizing the scope of appropriate device use. In order to more effectively market DABRA, we currently are pursuing expanded indications for use for DABRA to include an atherectomy indication for use, which the FDA currently defines to include a prespecified improvement in luminal patency, or a prespecified increase in the openness of the artery at a pre-defined time point. To satisfy the FDA’s data requirements to support an atherectomy indication, we submitted an investigational device exemption, or IDE, designed to gather the clinical data necessary to determine substantial equivalence in support of the atherectomy indication. This IDE was approved in July 2019. However, as a result of our voluntary DABRA catheter recall, discussed below, we plan to submit updates to the IDE and enroll the first patient in the first quarter of 2020. We believe the incremental cost of obtaining the atherectomy indication will not be material.

In the fourth quarter of 2018, we announced the prospective long-term revascularization study of DABRA titled REvascularization RateS and Clinical OUtcomes with DABRA Laser. A Long-Term 2-year Study (RESULTS). This registry is being conducted to measure the benefit and the safety profile of DABRA over a longer time frame (two years) than our pivotal trial, which had a 180 day follow up. We have case reports of patients with extended freedom from restenosis even out to over four years, which prompted us to study longer-term outcomes more closely. We treated the first patient in the registry in the second quarter of 2019 and we intend to provide additional updates on a periodic basis throughout the study.  

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In the future, we intend to pursue additional uses for DABRA, including seeking regulatory clearance or approval for the use of DABRA as a tool for the treatment of vascular blockages associated with coronary artery disease, or CAD, in-stent restenosis, and other venous and arterial occlusions, or blockages in the veins or arteries, although we are not currently pursuing any of these additional uses at this time. There can be no assurance that DABRA will receive the necessary clearances for these additional indications. The DABRA laser system is based on the same core technology and utilizes a similar excimer laser as Pharos, a medical device that we have marketed as a tool for the treatment of proliferative skin conditions since October 2004. Pharos is designed for use in the treatment of inflammatory skin conditions and is FDA cleared as a tool used in the treatment of psoriasis, vitiligo, atopic dermatitis, and leukoderma. Because DABRA and Pharos are both based on our core excimer laser technology platform and deploy similar mechanisms of action, we benefit from economies of scale in product development, manufacturing, quality assurance and distribution.

DABRA is our minimally-invasive excimer laser and single-use catheter system that is used by physicians as a tool in the endovascular treatment of vascular blockages resulting from lower extremity vascular disease, a form of PAD, both above- and below-the-knee, by breaking down plaque to its fundamental chemistry, such as proteins, lipids and other chemical compounds, eliminating blockages by essentially dissolving them without generating potentially harmful particulates. The accumulation of plaque in arteries, which is a result of lower extremity vascular disease, most commonly occurs in the pelvis and legs. Plaque accumulation, known as atherosclerosis, causes the narrowing of arteries, thereby reducing the flow of oxygenated blood to tissue and organs. If vascular blockages are left untreated, they can increase the risk of heart attack, stroke, amputation or death. In addition, studies have shown that older patients who undergo a major lower extremity amputation face a significant increased mortality risk. Major risk factors for PAD include age, smoking, diabetes and obesity. Despite its prevalence, PAD is underdiagnosed and undertreated relative to many other serious vascular conditions, including CAD, in part because up to half of the PAD population is asymptomatic, or shows no symptoms, and many dismiss symptoms as normal signs of aging. Recent analysis suggests that approximately 17.6 million people in the U.S. suffer from PAD. However, only 20-30% of PAD patients are actively being treated. We anticipate revenue from this recently commercialized business segment to grow over time. Our sales strategy includes either selling the DABRA laser with a transfer in title or placing it in high-volume practices for a nominal periodic fee while we retain title. We sell extended warranty service contracts for our lasers that have been purchased. Each vascular procedure requires the one-time use of our proprietary catheters which we expect to be the primary source of revenue for the vascular segment. Therefore, under both the sale and periodic fee options, we anticipate recurring revenue in catheter sales for each active laser in operation. We currently use our internal sales force in the U.S. and we utilize distributors outside the U.S.

Pharos is our excimer laser device that emits highly concentrated ultraviolet light and is used as a tool in the treatment of dermatological skin disorders. Physicians use Pharos by applying 308 nanometer ultraviolet light to the skin. The FDA has granted 510(k) clearance to market Pharos in the U.S. for psoriasis, vitiligo, atopic dermatitis, and leukoderma. Pharos was granted CE mark approval in September of 2016 for use in the treatment of psoriasis, vitiligo, atopic dermatitis and leukoderma by the application of UVB ultraviolet light. We have also received clearance to market Pharos from the China Food and Drug Administration, or CFDA and the Saudi Food and Drug Authority, or SFDA, in the applicable jurisdictions. Pharos was commercialized in 2004 and we have shipped over 1,000 systems to customers globally through June 30, 2019. Pharos is in use in nearly every U.S. state and in over 20 markets including several non-U.S. countries. While we have entered into periodic fee arrangements, our primary strategy is to sell Pharos. We recognize additional recurring revenue from the sale of extended warranty service contracts for Pharos. In July 2019, we announced updates to the design and performance of Pharos, including updated software designed to deliver faster treatments, as well as a more ergonomic handpiece.  

We incurred net losses of $29.8 million and $30.8 million for the six months ended June 30, 2019 and the year ended December 31, 2018, respectively, and had an accumulated deficit of $90.0 million as of June 30, 2019. As of June 30, 2019, we had available cash and cash equivalents and short-term investments of approximately $48.4 million and had current liabilities of approximately $6.3 million and long-term liabilities of approximately $4.3 million, which includes operating lease liabilities relating to our building leases of $2.8 million and equipment financings of $0.5 million. Since inception, we have financed our operations primarily through sales of our products and services, the net proceeds from our initial public offering, and, to a lesser extent, private placements of our common stock and equipment financing arrangements. We expect to continue to incur net losses for the near term as we commercialize our products in the U.S., including remedying the inconsistencies in our DABRA catheter performance, optimizing our manufacturing facilities, continuing research and development efforts, and seeking regulatory clearance for new products and product enhancements, including new indications, both in the U.S. and in select non-U.S. markets. We may need additional funding to pay expenses relating to our operating activities, including selling, general and administrative expenses and research and development expenses. If needed, adequate funding may not be available to us on commercially acceptable terms, or at all. Our failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, financial condition, and results of operations.

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Recent Developments

In the fourth quarter of 2018 and first quarter of 2019, we experienced inconsistencies in our DABRA catheter performance. We believed at the time, that these inconsistencies related to controlling the temperature of the oven used in the manufacturing process, which we had previously referred to as production limitations. These inconsistencies led to an increase in the number of catheters that failed to calibrate at customer sites, despite calibrating successfully during our quality assurance steps. During that same period, our sales team noted higher rates of non-calibration of catheters at customer physician offices. The higher than anticipated rates of non-calibration resulted in customer dissatisfaction with the product, resulting in what we believe to be fewer purchases by our customers and therefore lower revenue during the fourth quarter of 2018 and in 2019, however, such amount is not determinable. In response, we upgraded our temperature control regulator and made certain changes in our production flow and validated the changes that we believed corrected the production limitations. After manufacturing several well-performing lots with this upgraded process, the percentage of catheters that failed to calibrate began to increase after decreasing during April and May 2019. After collecting field data and performing internal testing, we observed that while catheters can perform satisfactorily up to one year, catheters that were more than two months from sterilization, had a significantly higher rate of non-calibration than catheters that were within two months from sterilization. As a result, in September 2019, we initiated a recall of our catheters to relabel them from a 12 month to a two month shelf life, which we believe will significantly reduce the number of catheters that fail to calibrate. The product related costs associated with the recall are aggregated in cost of revenue in the accompanying condensed statements of operations and amounted to $0.2 million for the three and six months ended June 30, 2019. Until our DABRA catheters consistently calibrate in the field, DABRA sales may continue to be adversely impacted and we will continue to incur additional costs.

In addition, we implemented certain operational efficiency and cost-savings initiatives intended to align our resources with our product strategy, reduce our operating expenses, and manage our cash flows. These cost efficiency initiatives include targeted workforce reductions of our sales and marketing teams. We have reduced the size of our DABRA sales force from 34 employees as of June 30, 2019 to 6 employees as of November 11, 2019. In the near term, we intend to focus on servicing priority existing accounts while we prioritize remedying the inconsistencies in our DABRA catheter performance.

Initial Public Offering

On October 1, 2018, we closed on our initial public offering, or IPO, of 4,485,000 shares of common stock at an offering price of $17.00 per share, which included the full exercise of the underwriters’ option to purchase 585,000 additional shares of our common stock. We raised a total of $76.2 million in gross proceeds from the IPO, or approximately $67.3 million in net proceeds after deducting underwriting discount and commissions of $5.3 million and offering costs of $3.6 million. Our registration statement on Form S-1 relating to our IPO was declared effective by the Securities and Exchange Commission on September 26, 2018.

Components of our Results of Operations

Net revenue

Product sales consist of the sale of DABRA and Pharos lasers, the sale of catheters for use with the DABRA laser and the sale of consumables and replacement parts.

Service and other revenue consists primarily of sales of extended warranty service contracts which we recognize over the contract period and billable services, including repair activity, which is recognized when the service is provided. It also includes income from the rental of our lasers.

We currently use our internal sales force in the U.S., and we utilize distributors outside the U.S. in markets where we have received regulatory approval. We expect to continue to seek regulatory approvals for our products in additional strategic markets.

Cost of revenue and gross margin

Cost of revenue for product sales consists primarily of costs of components for use in our products, the materials and labor that are used to produce our products, and the manufacturing overhead that directly support production.

Cost of revenue for service and other includes the cost of maintaining and servicing the warranties on our products.

We expect cost of revenue to increase to the extent our total revenue grows.

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We calculate gross margin as gross profit divided by total net revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily production volumes, the cost of direct materials, discounting practices, manufacturing costs, product yields, headcount and cost-reduction strategies. We expect our gross margin to be negatively impacted in the near term as we focus on remedying the inconsistencies in our product performance. We intend to use our design, engineering and manufacturing capabilities to further advance and improve the efficiency of our manufacturing processes, which we believe will reduce costs and increase our gross margin over the longer term. Even with consistent product performance, gross margin will likely fluctuate from quarter to quarter as we continue to adopt new manufacturing processes and technologies.

Research and development expenses

Research and development, or R&D, expenses consist of applicable personnel, consulting, materials and clinical trial expenses. R&D expenses include:

We expense R&D costs as incurred. In the future, we expect R&D expenses to increase as we continue to develop new products, enhance existing products and technologies and perform activities related to obtaining additional regulatory approval. However, we expect R&D expenses as a percentage of total revenue to vary over time depending on the level and timing of our new product development efforts, as well as our clinical development, clinical trials and studies and other related activities.

Selling, general and administrative expenses

Selling, general and administrative, or SG&A, expenses consist of employee-related expenses, including salaries, benefits, travel expense, sales commissions and stock-based compensation expense. Other SG&A expenses include promotional activities, marketing, conferences and trade shows, professional services fees, including legal, audit and tax fees, insurance costs, general corporate expenses, allocated facilities-related expenses and shipping and handling costs. In August 2019, we began implementing certain operational efficiency and cost savings initiatives intended to align our resources with our product strategy, reduce our operating expenses, and manage our cash flows. These cost efficiency initiatives include targeted workforce reductions of our sales and marketing teams. We have reduced the size of our DABRA sales force from 34 employees as of June 30, 2019 to 6 employees as of November 11, 2019. In the near term, we intend to focus on servicing priority existing accounts while we prioritize remedying the inconsistencies in our DABRA catheter performance. We expect continued increases in legal, accounting, insurance and other expenses associated with the legal proceedings discussed in Note 11, “Commitments and Contingencies,” in the notes to the condensed financial statements and with being a public company, compared to the three and six months ended June 30, 2018 when we were privately held.

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Results of Operations

The following table shows our results of operations (in thousands):