LENSAR, Inc. - Quarter Report: 2020 September (Form 10-Q)

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

For the quarterly period ended September 30, 2020

or

For transition period from                to

Commission File Number: 001-39473

LENSAR, INC.

(Exact name of registrant as specified in its charter)

2800 Discovery Drive

Orlando, Florida 32826

(Address of principal executive offices and Zip Code)

(888) 536-7271

(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 Securities Exchange Act of 1934:

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, indicated 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 October 31, 2020, there were 10,638,819 shares of the registrant’s Common Stock outstanding.

FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q (the “Quarterly Report”) contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We intend such forward-looking statements to be covered by the safe harbor provisions for forward-looking statements contained in Section 27A of the Securities Act of 1933, as amended (the “Securities Act”) and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”). All statements other than statements of historical facts contained in this Quarterly Report, including without limitation statements regarding our business model and strategic plans for our products, technologies and business, including our implementation thereof; the impact on our business, financial condition and results of operation from the ongoing and global COVID-19 pandemic; the timing of and our ability to obtain and maintain regulatory approvals; our expectations about our ability to successfully develop and commercialize our next generation compact cataract treatment system, ALLY, and the timing thereof; the sufficiency of our cash, cash equivalents and short-term investments; and the plans and objectives of management for future operations and capital expenditures are forward-looking statements. These statements involve known and unknown risks, uncertainties and other important factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by the forward-looking statements.

Without limiting the foregoing, in some cases, you can identify forward-looking statements by terms such as “aim”, “may,” “will,” “should,” “expect,” “exploring,” “plan,” “anticipate,” “could,” “intend,” “target,” “project,” “contemplate,” “believe,” “estimate,” “predict,” “potential,” “seeks,” or “continue” or the negative of these terms or other similar expressions, although not all forward-looking statements contain these words. No forward-looking statement is a guarantee of future results, performance, or achievements, and one should avoid placing undue reliance on such statements.

Forward-looking statements are based on our management’s beliefs and assumptions and on information currently available to us. Such beliefs and assumptions may or may not prove to be correct. Additionally, such forward-looking statements are subject to a number of known and unknown risks, uncertainties and assumptions, and actual results may differ materially from those expressed or implied in the forward-looking statements due to various factors, including, but not limited to, those identified in Part I. Item 2. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and Part II. Item 1A “Risk Factors” in this Quarterly Report. These risks and uncertainties include, but are not limited to:

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Moreover, we operate in an evolving environment. New risk factors and uncertainties may emerge from time to time, and it is not possible for management to predict all risk factors and uncertainties.

You should read this Quarterly Report and the documents that we reference in this Quarterly Report completely and with the understanding that our actual future results may be materially different from what we expect. We qualify all of our forward-looking statements by these cautionary statements. Except as required by applicable law, we do not plan to publicly update or revise any forward-looking statements contained herein, whether as a result of any new information, future events, changed circumstances or otherwise.

Unless otherwise stated or the context requires otherwise, references to “LENSAR,” the “Company,” “we,” “us,” and “our,” refer to LENSAR, Inc.

We own or have rights to certain trademarks, trade names, copyrights and other intellectual property used in our business, including LENSAR, the LENSAR logo, LENSAR Cataract Laser with Augmented Reality logo, Streamline, IntelliAxis, and IntelliAxis Refractive Capsulorhexis, each of which is considered a trademark. All other company names, product names, trade names and trademarks included in this Quarterly Report are trademarks, registered trademarks or trade names of their respective owners.

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Table of Contents

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PART I – FINANCIAL INFORMATION

LENSAR, Inc.

CONDENSED STATEMENTS OF OPERATIONS

(Unaudited)

(In thousands, except share and per share amounts)

The accompanying notes are an integral part of these condensed financial statements

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LENSAR, Inc.

CONDENSED BALANCE SHEETS

(Unaudited)

(In thousands, except share and per share amounts)

The accompanying notes are an integral part of these condensed financial statements

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LENSAR, Inc.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these condensed financial statements

The restricted cash balance is included as part of Other assets in the condensed balance sheets.

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LENSAR, Inc.

CONDENSED STATEMENTS OF CASH FLOWS, continued

(Unaudited)

(In thousands)

The accompanying notes are an integral part of these condensed financial statements

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LENSAR, Inc.

CONDENSED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY (DEFICIT)

(Unaudited)

(In thousands, except share and per share amounts)

The accompanying notes are an integral part of these condensed financial statements

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

Note 1. Overview and Basis of Presentation

Overview and Organization

LENSAR, Inc. (“LENSAR” or the “Company”) is a global medical device business focused on the design, development and commercialization of advanced technology for the treatment of cataracts and management of astigmatisms to achieve improved vision outcomes for patients. The Company’s revenue is derived from the sale and lease of the LENSAR Laser System, which may include equipment, a consumable referred to as the Patient Interface Devices (“PIDs”), procedure licenses, training, installation, limited warranty and maintenance agreements through extended warranty.

In September 2020, the Company’s parent entity, PDL BioPharma, Inc. (“PDL” or the “Parent”) announced its plans to pursue a separation and distribution of its medical device segment, which is solely comprised of its majority owned subsidiary LENSAR. On October 1, 2020, PDL completed the planned spin-off in the form of a dividend involving the distribution of substantially all outstanding shares of LENSAR common stock owned by PDL to holders of PDL common stock (“Spin-Off”) and LENSAR became a stand-alone publicly traded company. Refer to Note 15, Subsequent Events.

On September 10, 2020, the Company amended its amended and restated certificate of incorporation to effect a one-for-nine reverse stock split of the Company’s common stock. The par value of the Company’s common stock and the total number of shares of common stock that the Company is authorized to issue remained unchanged.

All issued and outstanding shares of common stock, other common stock share numbers, equity awards and per share amounts contained in the condensed financial statements have been retroactively adjusted to give effect to the reverse stock split for all periods presented.

The Company has incurred recurring losses and operating cash outflows since its inception and as of September 30, 2020 had an accumulated deficit of $51,165. The Company expects to continue to incur losses and cash outflows from operating activities for the foreseeable future. In addition, the Company’s results of operations, financial condition and cash flows have been adversely affected by the COVID-19 pandemic. The extent to which the COVID-19 outbreak will further negatively impact the Company’s business or operating results cannot be determined with certainty at this time. In geographies in which the Company or its customers, partners and service providers operate, health concerns as well as political or governmental developments in response to COVID-19 could result in further economic, social or labor instability or prolonged contractions in the industries in which the Company’s customers or partners operate, slow the sales process, result in customers not purchasing or renewing the Company’s products or failing to make payments, and could otherwise have a material adverse effect on the Company’s business and results of operations and financial condition.

During the three months ended September 30, 2020, PDL and the Company entered into a series of recapitalization transactions and capital contribution transactions as described below. Management believes the Company’s cash on hand provides sufficient liquidity to meet the Company’s projected obligations for a period of at least twelve months from the date of issuance of the financial statements.

Description of the Recapitalization Transactions and Capital Contributions

On July 10, 2020, the Company amended and restated its certificate of incorporation to, among other things, (a) increase the number of shares of common stock ($0.01 par value per share) the Company is authorized to issue to 150,000,000 shares and (b) issue to PDL a total of 3,414,825 shares of the Company’s common stock in exchange for the extinguishment of all 30,000 shares of the Company’s Series A Preferred Stock, including any accrued and unpaid dividends thereon (the “Series A Preferred Stock Recapitalization”). As of September 30, 2020, the Company does not have any shares of Series A Preferred Stock outstanding.

On July 13, 2020, the Company and PDL entered into a contribution and exchange agreement whereby the Company issued to PDL a total of 2,806,244 shares of the Company’s common stock in exchange for the extinguishment of the $32,600 outstanding that the Company owed PDL under the loan agreement (the “Note Payable Recapitalization”).

The Series A Preferred Stock Recapitalization, together with the Note Payable Recapitalization, is defined as the “Recapitalization Transactions”. The Recapitalization Transactions resulted in the issuance of 6,221,069 shares of common stock with a fair value of $67,188 to extinguish an aggregate of $69,879 carrying value of liabilities recognized for the Series A Preferred Stock inclusive of accumulated dividend and loans outstanding under the loan agreement inclusive of accrued interest, resulting in an approximate $2,691 extinguishment gain recorded in additional paid-in capital during the three months ended September 30, 2020. The estimated fair value of the common stock was determined by the board of directors, with input from management. In the absence of a public

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

trading market for the common stock, the Company developed an estimate of the fair value of the common stock based on the information known as of the date of the Recapitalization Transactions, upon a review of any recent events and their potential impact on the estimated fair value, and valuations from an independent third-party valuation firm. Valuations of the Company’s common stock were determined in accordance with the guidelines outlined in the American Institute of Certified Public Accountants Practice Aid, Valuation of Privately-Held-Company Equity Securities Issued as Compensation, or the Practice Aid. In evaluating the fair value of common stock, the Company first established the enterprise value of the Company using generally accepted valuation methodologies including discounted cash flow analysis, comparable public company analysis and comparable acquisitions analysis. Then the Company allocated the equity value among the fully diluted shares outstanding as a result of the Recapitalization Transactions.

On July 21, 2020, the Company issued an additional 740,740 shares of common stock to PDL in exchange for $8,000 in cash (the “Capital Contribution”).

On August 4, 2020, PDL committed that through August 5, 2021 it would provide financial support of up to $20,000 to support the operating, investing and financing activities of the Company. On August 24, 2020, the Company received cash of $29,000 from PDL (the “Additional Capital Contribution”). The Company issued 746,767 shares of common stock to PDL in exchange for $8,334. The remaining $20,666 was a cash contribution from PDL. In connection with the Additional Capital Contribution, PDL’s financial support under its commitment on August 4, 2020 was fulfilled.

On September 29, 2020, the Company issued an additional 8,703 shares of additional common stock to PDL in exchange for $97 in cash.

Basis of Presentation

The condensed financial statements of the Company are unaudited and have been prepared in accordance with generally accepted accounting principles in the United States of America (“U.S. GAAP”) and pursuant to the regulations of the U.S. Securities and Exchange Commission (“SEC”) for interim financial information and, therefore, omit or condense certain footnotes and other information normally included. The condensed financial statements include all adjustments (consisting only of normal recurring adjustments), that management of the Company believes are necessary for a fair statement of the periods presented. These interim financial results are not necessarily indicative of results expected for the full fiscal year.

The accompanying unaudited condensed financial statements and related financial information should be read in conjunction with the Company’s annual audited financial statements and the related notes thereto for the fiscal year ended December 31, 2019, included in the information statement included as Exhibit 99.9 to the Registration Statement on Form 10, as amended and filed with the SEC on September 14, 2020.

These condensed financial statements were prepared on a stand-alone basis derived from the unaudited condensed consolidated financial statements and accounting records of PDL and are presented as if LENSAR had been operating as a stand-alone company for all periods presented. These condensed financial statements exclude the assets, liabilities, revenue and expenses directly attributable to LENSAR’s wholly owned subsidiary, PDL Investment Holdings, LLC (“PDLIH”). On August 20, 2020, the Company distributed 100% of its ownership interest in its wholly owned subsidiary, PDLIH, to PDL. This distribution will not result in US Federal or State income tax effects due to an election made by the Company and PDL following the Company’s separation from PDL under Internal Revenue Code (“IRC”) Section 336(e) which provides for a recharacterization of the distribution of stock as a deemed sale of assets for tax purposes. This election was made following the Spin-Off of all outstanding shares of LENSAR common stock owned by PDL to holders of PDL common stock. Refer to Note 15, Subsequent Events.

The assets, liabilities, revenue and expenses directly attributable to the Company’s operations have been reflected in these condensed financial statements on a historical cost basis, as included in the consolidated financial statements of PDL. The condensed statements of operations include expenses for certain corporate support functions that are provided by PDL such as administration and organizational oversight; including employee benefits, finance and accounting, treasury and risk management, professional and legal services, among others. These expenses have been allocated to the Company on the basis of direct usage when identifiable, with the remainder allocated on a proportional basis of expenses of the Company and PDL. Management of the Company and PDL considered the basis on which the expenses have been allocated to be a reasonable reflection of the utilization of services provided to or the benefit received by the Company during the periods presented. These allocations may not be reflective of the expenses that would have been incurred had the Company operated as a separate, unaffiliated entity apart from PDL. Actual costs that would have been incurred if LENSAR had been a stand-alone, public company would depend on multiple factors, including the chosen organizational

11

NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

structure and strategic decisions made in various areas, including information technology and infrastructure. Following its separation on October 1, 2020, the Company expects to perform these functions using its own resources or purchased services. For an interim period in 2021, however, some of these functions will continue to be provided by PDL as the Company entered into a transition service agreement with PDL in connection with the separation. Refer to Note 15, Subsequent Events.

The Company was historically funded as part of PDL’s treasury program. Cash and restricted cash managed through bank accounts legally owned by PDL at the corporate level were not attributable to the Company for any of the periods presented. Only cash and restricted cash legally owned by the Company are reflected in the condensed balance sheets. All significant transactions between the Company and PDL are considered to be effectively settled for cash at the time the transaction is recorded, unless otherwise noted. Such transfers of cash to and from PDL have been included in these condensed financial statements as a component of equity in the condensed balance sheets and as a financing activity in the condensed statements of cash flows, unless otherwise noted.

During the periods presented in these condensed financial statements, the operations of the Company were included in the consolidated U.S. federal and state income tax returns filed by PDL. Income tax expense and other income tax related information contained in the condensed financial statements are presented on a separate return basis as if the Company had filed its own tax returns. The deferred income taxes of the Company as presented in these condensed financial statements, including tax attributes such as net operating losses or credit carryforwards, are not indicative of the deferred tax assets available to the Company in the future as described within Note 15, Subsequent Events. The Company’s uncertain tax positions recorded under the separate return method may also differ from those recorded in the PDL financial statements. See Note 12, Income Taxes, for more information.

In addition, as a result of the impact of COVID-19 as discussed above, the Company determined certain impairment triggers had occurred during the three months ended March 31, 2020 related to the Company’s finite-lived tangible and intangible assets. Accordingly, the Company analyzed undiscounted cash flows at the asset group level for certain finite-lived tangible and intangible assets as of March 31, 2020. Based on that undiscounted cash flow analysis, the Company determined that estimated undiscounted future cash flows substantially exceeded their net carrying values, and, therefore, as of March 31, 2020, the Company’s finite-lived tangible and intangible assets were not impaired.

Note 2. Summary of Significant Accounting Policies

Other than policies noted below, there have been no significant changes to the significant accounting policies disclosed in Note 2, Summary of Significant Accounting Policies, of the annual audited financial statements included in the information statement included in Exhibit 99.9 to the Registration Statement.

Accounting Estimates

The preparation of condensed financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed financial statements and accompanying notes to the condensed financial statements. The accounting estimates that require management’s most significant, difficult and subjective judgments include, but are not limited to, cost allocations from PDL, revenue recognition and allowance for doubtful accounts, the valuation of notes receivable and inventory, the assessment of recoverability of intangible assets and their estimated useful lives, the valuation and recognition of stock-based compensation, operating lease right-of-use assets and liabilities, and the recognition and measurement of current and deferred income tax assets and liabilities. Management evaluates its estimates on an ongoing basis as there are changes in circumstances, facts, and experience. Changes in estimates are recorded in the period in which they become known. Actual results could differ from these estimates.

The full extent to which the COVID-19 pandemic will directly or indirectly impact the Company’s business, results of operations and financial condition, including revenue, expenses, reserves and allowances, will depend on future developments that are highly uncertain, including as a result of new information that may emerge concerning COVID-19 and the actions taken to contain or treat it, as well as the economic impact on domestic and international customers and markets. The Company has made estimates of the impact of COVID-19 within its condensed financial statements and there may be changes to those estimates in future periods.

As of the date of issuance of these unaudited condensed interim financial statements, the Company is not aware of any specific event or circumstance that would require the Company to update estimates, judgments or revise the carrying value of any assets or liabilities.

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

Fair Value Measurement

The fair value of the Company’s financial instruments are estimates of the amounts that would be received if the Company were to sell an asset or the Company paid to transfer a liability in an orderly transaction between market participants at the measurement date or exit price. The assets and liabilities are categorized and disclosed in one of the following three categories:

Fair value measurements are classified in their entirety based on the lowest level of input that is significant to their fair value measurement.

The carrying value of the Company’s cash, accounts receivable, accounts payable, accrued liabilities, and other current liabilities approximate the fair value based on the short-term maturities of these instruments. The carrying value of the Company’s notes receivable also approximates the fair value based on the associated credit risk.

Adopted Accounting Pronouncement

In June 2016, the Financial Accounting Standards Board (“FASB”) issued Accounting Standard Update (“ASU”) No. 2016-13, Financial Instruments—Credit Losses: Measurement of Credit Losses on Financial Instruments (“ASC 326”). The new guidance amends the impairment model to utilize an expected loss methodology in place of the currently used incurred loss methodology, which will result in more timely recognition of losses. The Company adopted ASU No. 2016-13 on January 1, 2020 using a modified retrospective approach. The adoption resulted in a $34 adjustment to the Company’s accumulated deficit opening balance within the condensed balance sheets. As a consequence of adopting ASU 2016-13, the Company’s accounts and notes receivable accounting policy has been updated.

Accounts and Notes Receivable

The Company makes estimates of the collectability of accounts receivable. In doing so, the Company analyzes historical bad debt trends, customer credit worthiness, current economic trends, changes in customer payment patterns, and possible impact of current conditions and reasonable forecasts not already reflected in historical loss information when evaluating the adequacy of the allowance for credit losses. Amounts are charged off against the allowance for credit losses when the Company determines that recovery is unlikely, and the Company ceases collection efforts.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software. The new guidance reduces complexity for the accounting for costs of implementing a cloud computing service arrangement and aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software (and hosting arrangements that include an internal use software license). The Company adopted ASU No. 2018-15 on January 1, 2020 using the prospective transition option. The adoption did not have a material impact on the condensed financial statements.

In April 2020, the FASB issued a staff question-and-answer document, “Topic 842 and Topic 840: Accounting for Lease Concessions Related to the Effects of the COVID-19 Pandemic” (the “COVID-19 Q&A”), to address certain frequently-asked questions pertaining to lease concessions arising from the effects of the COVID-19 pandemic. Existing lease guidance requires entities to determine if a lease concession was a result of a new arrangement reached with the lessee (which would be addressed under the lease modification accounting framework) or if a lease concession was under the enforceable rights and obligations within the existing lease agreement (which would not fall under the lease modification framework). The COVID-19 Q&A clarifies that entities may elect to not evaluate whether lease-related relief granted in light of the effects of COVID-19 is a lease or obligations of the lease. This election is available for concessions that result in the total payments required by the modified contract being substantially the same or less than the total payments required by the original contract.

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

The Company elected to account for lease concessions related to the effects of the COVID-19 pandemic in accordance with the COVID-19 Q&A. LENSAR entered into agreements with 23 customers through which LENSAR agreed to waive monthly rental fees ranging from one to three months. A total of zero and $335 in lease revenue was not recognized during the three and nine months ended September 30, 2020, respectively, related to the waived lease payments. There were no concessions provided for any non-lease components of the lease arrangements. In return for these concessions the related contracts were extended by the same number of months waived. No amounts of accounts receivable or notes receivable were deemed uncollectible due to COVID-19 as of September 30, 2020; however, the Company considered the effects of COVID-19 in estimating its credit losses for the period.

Recently Issued Accounting Pronouncements Not Yet Adopted

In December 2019, the FASB issued ASU No. 2019-12, which is intended to simplify various aspects related to accounting for income taxes. ASU 2019-12 removes certain exceptions to the general principles in Topic 740 and also clarifies and amends existing guidance to improve consistent application. The amendments in ASU No. 2019-12 are effective for fiscal years, and interim periods within those fiscal years, beginning after December 15, 2020, with early adoption permitted. The Company does not expect this guidance to have a significant impact on its financial statements and related disclosures.

Note 3. Revenue from Contracts with Customers

Disaggregation of Revenue

The following table summarizes the Company’s product and service revenue disaggregated by geographic region, which is determined based on customer location, for the three and nine months ended September 30, 2020 and 2019:

¹ The table above does not include lease revenue of $1,073 and $1,113 for three months ended September 30, 2020 and 2019, respectively, and $2,519 and $3,173 for the nine months ended September 30, 2020 and 2019, respectively. Refer to Note 5, Leases.

Contract Balances

The following table provides information about receivables and contract liabilities from contracts with customers:

Accounts Receivables, Net – Accounts receivables, net, include amounts billed and due from customers. The amounts due are stated at their net estimated realizable value and are classified as current or noncurrent based on the timing of when the Company expects to receive payment. Most customers are on pre-paid or 30-day payment terms, depending on the product purchased. The Company maintains an allowance for credit losses to provide for the estimated amount of receivables that will not be collected. The allowance is based upon an assessment of customer credit worthiness, historical payment experience, the age of outstanding receivables, collateral

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

to the extent applicable and reflects the possible impact of current conditions and reasonable forecasts not already reflected in historical loss information.

The following table summarizes the activity in the allowance for accounts receivable:

Notes Receivables, Net – Notes receivable, net includes amounts billed and due from customers under extended payment terms with a significant financing component. Interest rates on notes receivable range from 5.0% to 5.75%. The Company recorded interest income on notes receivable during the three months ended September 30, 2020 and 2019 of $13 and $12, respectively, and for the nine months ended September 30, 2020 and September 30, 2019 of $42 and $38, respectively, in Other income, net in its condensed statements of operations.

The following table summarizes the activity in the allowance for notes receivable:

Contract Liabilities – The Company’s contract liabilities consist of deferred revenue related to services and products sold to customers for which the performance obligation has not been completed by the Company. The Company classifies deferred revenue as current or noncurrent based on the timing of when it expects to recognize revenue. The noncurrent portion of deferred revenue is included in other long-term liabilities in the Company’s condensed balance sheets.

The following table provides information about contract liabilities from contracts with customers:

Transaction Price Allocated to Future Performance Obligations

At September 30, 2020, the revenue expected to be recognized in future periods related to performance obligations that are unsatisfied for executed contracts with an original duration of one year or more was approximately $9,159. The Company expects to satisfy its

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

remaining performance obligations over the next four years, with $4,811 to be satisfied in the next twelve months, $2,112 to be satisfied in the next two years, and $2,236 to be satisfied thereafter. The Company does not disclose the value of unsatisfied performance obligations for (i) contracts with original expected lengths of one year or less or (ii) contracts for which the Company recognizes revenue at the amount to which it has the right to invoice for the products delivered or services performed.

Note 4. Inventories

Inventory balances were as follows:

Note 5. Leases

Lessor Arrangements

The Company has operating leases for the LENSAR Laser System. The Company’s leases have remaining lease terms of less than one year to four years. Lease revenue for the three and nine months ended September 30, 2020 and 2019 was as follows:

Lessee Arrangements

The Company has an operating lease for its corporate office and manufacturing facility. On August 20, 2020, the Company amended its lease pursuant to which the term of the lease was extended through November 30, 2027 commencing on September 1, 2020. The lease amendment constitutes a modification as it extends the original lease term, which requires evaluation of the remeasurement of the lease liability and corresponding right-of-use-asset. The reassessment resulted in continuing to classify the lease as an operating lease and remeasurement of the lease liability on the basis of the extended lease term and the incremental borrowing rate at the effective date of modification of 10%. The remeasurement for the modification resulted in an increase to the lease liability and the right-of-use-asset of $3,320.

Following the change, the Company's maturities of lease liabilities as of September 30, 2020 were as follows:

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

Note 6. Intangible Assets

In April 2019, LENSAR acquired certain intellectual property from a third-party for $2,000 in cash and contingent obligations to pay a $300 milestone payment and royalties upon the completion of certain events. The $300 milestone payment was paid prior to December 31, 2019.

The components of intangible assets were as follows:  

Amortization expense for three months ended September 30, 2020 and 2019 was $313 and $317, respectively, and for the nine months ended September 30, 2020 and 2019 $944 and $910, respectively.

Based on the intangible assets recorded at September 30, 2020, and assuming no subsequent additions to or impairment of the underlying assets, the remaining amortization expense is expected to be as follows:

Note 7. Accrued Liabilities

Accrued liabilities consist of the following:

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

Note 8. Series A Preferred Stock

The Company authorized and issued 30,000 shares of Series A Preferred Stock, par value $0.01 to PDL in May 2017. The Series A Preferred Stock had an aggregate liquidation preference of $30,000 (“stated value”), plus all accumulated and unpaid dividends (whether or not declared). Dividends on each share of Series A Preferred Stock initially accrued on an annual basis at a rate of 15.0% per annum of the stated value, and subsequently decreased to 5.0% per annum of the stated value effective January 1, 2019 as amended in December 2018.

Dividends were to be payable when and if declared by the board of directors. No dividends were declared by the board of directors from the time of issuance to the Series A Preferred Stock Recapitalization.

The Series A Preferred Stock was accounted for as a liability on the Company’s condensed balance sheets because it was mandatorily redeemable. Upon completion of the Series A Preferred Stock Recapitalization, the Company does not currently have any shares of Series A Preferred Stock outstanding. See Note 1, Overview and Basis of Presentation, for more information on the Series A Preferred Stock Recapitalization. Interest expense recognized on the Series A Preferred Stock is $32 and $382 for the three months ended September 30, 2020 and 2019, respectively. Interest expense recognized on the Series A Preferred Stock is $829 and $1,145 for the nine months ended September 30, 2020 and 2019, respectively.

Note 9. Commitments and Contingencies

Purchase Obligation

LENSAR entered into various supply agreements for the manufacture and supply of certain components. The supply agreements commit LENSAR to a minimum purchase obligation of approximately $2,543 over the next nine months. LENSAR expects to meet these requirements. LENSAR made purchases of $1,677 and zero under these supply agreements during the nine months ended September 30, 2020 and 2019, respectively.

Royalty and Milestone Payments

In connection with the acquisition of certain intellectual property the Company could be required to make milestone payments in the amount of $2,400 which are contingent upon the regulatory approval and commercialization of the next generation system. In addition, the Company acquired certain intellectual property, which if used in the development of the next generation system could result in additional royalty payments.

Legal Matters

The medical device market in which LENSAR participates is largely technology driven. As a result, intellectual property rights, particularly patents and trade secrets, play a significant role in product development and differentiation. The Company makes provisions for liabilities when it is both probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Management believes that there are currently no claims or legal actions that would reasonably be expected to have a material adverse effect on the Company’s results of operations, financial condition or cash flows.

Note 10. Stockholders’ Equity (Deficit)

Common Stock

The Company has a single class of common stock in which stockholders are entitled to one vote for each share of common stock. No cash dividend was declared on common stock during the three and nine months ended September 30, 2020 and 2019.

Note 11. Stock-Based Compensation

Phantom Stock Plan

LENSAR had a phantom stock plan under which it granted phantom stock units to LENSAR directors and employees. In connection with the Company’s issuance of restricted stock awards under the 2020 Plan (as defined below), all remaining outstanding awards under the Phantom Stock Plan were cancelled, and no further awards are outstanding under such plan. As such, the liability recorded

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

for unvested phantom stock units was remeasured at fair value immediately prior to the modification on July 22, 2020, which resulted in a decrease in fair value of $108. The fair value of $306 was reclassified from Accrued liabilities to Additional paid-in capital on the modification date. The fair value of the underlying common stock was determined using preliminary valuation techniques with the most reliable information currently available.

The following table summarizes the phantom share activity during the nine months ended September 30, 2020:

Stock-Based Incentive Plans

The 2020 Plan

On July 9, 2020, the Board of Directors approved the LENSAR Inc. 2020 Incentive Award Plan (the “2020 Plan”). Under the 2020 Plan, the Company is authorized to issue up to 3,333,333 shares in the form of stock options, restricted stock, restricted stock unit awards and other stock-based awards. The amount and terms of grants are determined by the Company’s Board of Directors or a duly authorized committee thereof. Participants must pay the Company, or make provisions to pay, any required withholding taxes by the date of the event creating the tax liability. Participants may satisfy the tax liability in cash or in stock.

On July 22, 2020, the Board of Directors approved the grants of 1,847,298 shares of restricted stock in connection with the proposed Spin-Off to certain individuals under the 2020 Plan in consideration of future services to be rendered to the Company. The aggregate grant date fair value of these restricted stock awards was determined to be $19,951 or $10.80 per share based on the fair value of the underlying common stock using preliminary valuation techniques with the most reliable information currently available. The vesting schedule of the restricted stock awards is (i) 40% vest on the later of three months following the completion of the proposed Spin-Off or six months following the grant date (provided the proposed Spin-Off has occurred prior to such date), (ii) 30% vest 18 months following grant date, and (iii) 30% vest 36 months following grant date.

The fair value of awards granted under the 2020 Plan will be recognized using a straight-line attribution method over the service period, except for portions of the award subject to performance conditions which will be recognized ratably over the service period for each separate performance vesting tranche. Awards subject to the performance condition were considered probable of vesting as of September 30, 2020. No restricted stock awards were vested as of September 30, 2020.

The weighted-average grant date fair value for restricted stock awards granted under the 2020 Plan for the three and nine months ended September 30, 2020 was $10.80 and $10.80, respectively.

At September 30, 2020, there was approximately $16,101 of total unrecognized compensation expense related to restricted stock awards, which is expected to be recognized over a weighted-average period of 1.4 years.

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

The following table sets forth the total stock-based compensation expense recognized under the Phantom Stock Plan and the 2020 Plan in the Company’s condensed statements of operations:

PDL Equity Incentive Plan

PDL has equity incentive plans under which it grants equity awards, including stock options, stock appreciation rights, restricted stock awards, restricted stock unit awards, performance share and performance unit awards, deferred compensation awards and other stock-based or cash-based awards.

Stock-based compensation expense related to the PDL awards for the three months ended September 30, 2020 and 2019 was approximately $15 and $28 and for the nine months ended September 30, 2020 and 2019 was approximately $53 and $73 recorded in selling, general, and administrative expenses, respectively.

The total fair value of restricted stock awards vested during the nine months ended September 30, 2020 and 2019 was approximately $65 and zero, respectively.

Note 12. Income Taxes

The Company is included in the consolidated federal tax return of PDL until the date of the Spin-Off. Refer to Note 15, Subsequent Events. The provision for income taxes is calculated by using a “separate return” method. Under this method, the Company is assumed to file a separate return with the applicable tax authority(ies). The current provision is the amount of tax payable or refundable on the basis of a hypothetical, current-year separate return. Deferred taxes are provided on temporary differences and on any attributes being carried forward that could be claimed on the hypothetical return. The need for a valuation allowance is assessed on a separate company basis and on projected separate return assets.

Income tax expense/(benefit) from continuing operations for the three and nine months ended September 30, 2020 and 2019, was zero in each period, which resulted primarily from maintaining a full valuation allowance against the Company’s deferred tax assets.

In response to the COVID-19 pandemic, many governments have enacted or are contemplating measures to provide aid and economic stimulus. The Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”), which was enacted on March 27, 2020 in the U.S., includes measures to assist companies, including temporary changes to income and non-income-based tax laws. The enactment of the CARES Act did not have a material effect on current income tax expense or the realizability of deferred income tax assets. The Company will monitor additional guidance and impact that the CARES Act and other potential legislation may have on its income taxes.

Note 13. Net Loss per Share

The following is a reconciliation of the numerator (net loss) and the denominator (number of shares) used in the basic and diluted net loss per share calculations:

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

The Company applied the two-class method for calculating net loss per share. The two-class method is an allocation of losses between the holders of common stock and the Company’s participating securities. Net loss attributable to common stockholders is computed by deducting the dividends accumulated for the period on the Series A Preferred Stock from the Company’s net loss. Interest expense on the Series A Preferred Stock is calculated using the effective interest method. The adjustment, if any, to the net loss is the portion of the cumulative dividends in excess of the interest expense on the Series A Preferred Stock. There were no cumulative dividends in excess of interest expense during the three and nine months ended September 30, 2020 and 2019.

The Company’s basic net loss per share attributable to common stockholders is computed by dividing the net loss attributable to common stockholders by the weighted-average number of shares of common stock outstanding during the period.

As the Company has reported a net loss for all periods presented, basic and diluted net loss per share attributable to common stockholders are the same for those periods.  For the three months and nine months ended September 30, 2020, the Company excluded 1,847,298 shares underlying restricted stock awards, from its net loss per diluted share calculations because their effect was anti-dilutive. Under the 2020 Plan, there were zero outstanding restricted stock awards in 2019.

Note 14. Related Party Transactions

In the ordinary course of business, the Company entered into transactions with PDL.

Corporate Allocations

The Company’s condensed financial statements include expenses of $637 and $917 for the three months ended September 30, 2020 and 2019, respectively and $3,387 and $3,178 for the nine months ended September 30, 2020 and 2019, respectively, allocated to the Company by PDL for corporate support functions that are provided by PDL such as administration and organizational oversight; including employee benefits, finance and accounting, treasury and risk management, professional and legal services, among others. Allocated costs are included within selling, general and administrative expenses in the accompanying condensed statements of operations. A portion of these allocated costs related to certain cross charges that have historically been cash settled and included in the condensed statements of cash flows as operating activities. As of September 30, 2020 and December 31, 2019, $1,098 and $142, respectively, related to the allocation of corporate costs are included in other current liabilities as those amounts are to be cash settled.

No costs related to the separation of LENSAR incurred by PDL have been allocated to the Company for the three and nine months ended September 30, 2020.

Note Payable to Related Party

In May 2017, the Company entered into a loan agreement with PDL. Under the loan agreement, the maximum aggregate principal amount that LENSAR can draw from the loan agreement is $25,600. On April 15, 2020, the Company and PDL, upon mutual agreement, increased the credit limit that LENSAR can draw from PDL under the loan agreement by $7,000 to a total of $32,600. LENSAR drew an additional $12,400 under the loan agreement during the nine months ended September 30, 2020. Immediately before the Note Payable Recapitalization, the Company had drawn the full amount under the amended loan agreement. The interest expense incurred during the three months ended September 30, 2020 and 2019 was $33 and $112, respectively, and is included in interest expense. The interest expense incurred during the nine months ended September 30, 2020 and 2019 was $511 and $302, respectively, and is included in interest expense.

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NOTES TO CONDENSED INTERIM FINANCIAL STATEMENTS
(Unaudited)
(In thousands, except shares or per share amounts)

Upon completion of the Note Payable Recapitalization, as of September 30, 2020 the Company does not have a Note payable due to related party. See Note 1, Overview and Basis of Presentation, for more information on the Note Payable Recapitalization.

Series A Preferred Stock

Refer to Note 8, Series A Preferred Stock.

Agreements with PDL

In connection with the completion of the Spin-Off, the Company entered into several agreements with PDL, each dated September 30, 2020, that, among other things, provide a framework for the Company’s relationship with PDL after the Distribution, including the following (collectively, the “Spin Agreements”):

Note 15. Subsequent Events

On October 1, 2020, PDL completed the previously planned Spin-Off in the form of a dividend involving the distribution of all outstanding shares of LENSAR common stock owned by PDL to holders of PDL common stock (“Distribution”). The Distribution was made to PDL’s stockholders of record as of the close of business on September 22, 2020 (the “Record Date”) and such stockholders received 0.075879 shares of LENSAR common stock for one PDL common share held as of close of business on the Record Date. Prior to the Distribution, PDL owned approximately 81.5% of LENSAR common stock. Following the completion of the distribution, PDL does not own any equity interest in LENSAR. LENSAR became an independent public company whose stock is listed and trading under the symbol “LNSR” on the Nasdaq Stock Market.

During the periods presented in these condensed financial statements, the operations of the Company were included in the consolidated U.S. federal and state income tax returns filed by PDL. For income tax purposes, LENSAR and PDL jointly made an election under IRC Section 336(e) which provides for a recharacterization of the Distribution of stock as a deemed sale of assets. This election was made following the Spin-Off and is effective as of October 2, 2020. As a result of this election, LENSAR’s research and development credits and net operating losses will remain with PDL, and LENSAR will record a tax-basis step up adjustment to reflect the fair value of all assets and liabilities on the date of the Spin-Off for tax purposes.

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The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our financial statements and the related notes included elsewhere in this Quarterly Report, as well as the audited financial statements and the related notes thereto, and the discussion under “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Business” included in our Information Statement on Form 10 filed with the U.S. Securities and Exchange Commission (“SEC”) on September 14, 2020 (the “Information Statement”). Some of the information contained in this discussion and analysis or set forth elsewhere in this Quarterly Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks, uncertainties and other factors that could cause actual results to differ materially from those made, projected or implied in the forward-looking statements. Please see the “Risk Factors” section for a discussion of the uncertainties, risks and assumptions associated with these statements.

Spin-Off

On October 1, 2020, PDL completed the Spin-Off of its medical device business in the form of a dividend involving the distribution of substantially all outstanding shares of LENSAR common stock owned by PDL to holders of PDL common stock (“Spin-Off”). The Spin-Off created a separate, independent, publicly traded global medical device company focused on designing, developing and marketing an advanced femtosecond laser system for the treatment of cataracts and the management of pre-existing or surgically induced corneal astigmatism. In connection with the Spin-Off, our stock began trading under the symbol “LNSR” on the Nasdaq Stock Market.

Our historical financial statements have been prepared on a stand-alone basis and are derived from PDL’s consolidated financial statements and accounting records. Our financial statements reflect, in conformity with accounting principles generally accepted in the United States, our financial position, results of operations, and cash flows as the business was historically operated as part of PDL prior to the Spin-Off. The condensed statements of operations include direct expenses for cost of revenue; research and development; selling, general and administrative expenses; and amortization, as well as allocated expenses for certain corporate support functions that are provided by PDL, such as administration and organizational oversight, including employee benefits, finance and accounting, treasury and risk management, professional and legal services, among others. These expenses have been allocated to us on the basis of direct usage when identifiable, with the remainder allocated on a proportional basis of our expenses and expenses of PDL. Our management and PDL’s management considered the basis on which the expenses have been allocated to be a reasonable reflection of utilization of services provided to or to the benefit received by us during the periods presented. These allocations may not be reflective of the expenses that would have been incurred had we operated as a separate, unaffiliated entity apart from PDL. Actual costs that would have been incurred if we had been a stand-alone, public company would depend on multiple factors, including the chosen organizational structure and strategic decisions made in various areas, including information technology and infrastructure.

Transactions with PDL that are expected to be settled for cash are reflected as outstanding in our condensed balance sheets. These transactions primarily include payables to PDL related to certain historical cross charge cost allocations as of September 30, 2020. The cash flows related to payables due to PDL for these certain historical cross charge cost allocations are reflected in our condensed statements of cash flows as operating activities. The cash flows, prior to our recapitalization related to the note payable due to PDL and our Series A Preferred Stock are reflected in our condensed statements of cash flows as financing activities since these balances represent amounts financed by PDL. Transactions with PDL that have not been historically settled in cash or are not expected to be settled in cash have been included in the condensed balance sheets as a component of equity and are reflected in our condensed statements of cash flows as financing activities. In July 2020, we entered into a contribution and exchange agreement with PDL, whereby we issued to PDL a total of 2,806,244 shares of our common stock in exchange for the extinguishment of the $32.6 million outstanding, including accrued interest, we owed to PDL under the term loan facility we entered into with PDL in May 2017 and amended in July 2020, or the Credit Agreement. In July 2020, we issued to PDL a total of 3,414,825 shares of our common stock in exchange for the extinguishment of all 30,000 shares of our Series A Preferred Stock, including any accrued and unpaid dividends thereon. We currently do not have any shares of Series A Preferred Stock outstanding. On September 10, 2020, we amended and restated our certificate of incorporation to effect a one-for-nine reverse stock split of our common stock. All issued and outstanding shares of common stock, other common stock share numbers, equity awards and per share amounts contained in the financial statements have been retroactively adjusted to give effect to the reverse stock split for all periods presented.

In connection with the Spin-Off, we entered into several agreements with PDL that govern the future relationship between us and PDL and impose certain obligations on us following the Spin-Off and which may cause us to incur new costs, including a Separation and Distribution Agreement, a Transition Services Agreement and a Tax Matters Agreement.

As an independent public company, we expect to perform the functions described above using our own resources or purchased services. For an interim period, however, some of these functions may continue to be provided by PDL under the transition service agreements with PDL as described above in connection with the Spin-Off.

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Overview

We are a commercial-stage medical device company focused on designing, developing and marketing an advanced femtosecond laser system for the treatment of cataracts and the management of pre-existing or surgically induced corneal astigmatism. Our LENSAR Laser System incorporates a range of proprietary technologies designed to assist the surgeon in obtaining better visual outcomes, efficiency and reproducibility by providing advanced imaging, simplified procedure planning, efficient design and precision. We believe the cumulative effect of these technologies results in a laser system that can be quickly and efficiently integrated into a surgeon’s existing practice, is easy to use and provides surgeons the ability to deliver improved visual outcomes. As we continue to innovate, we are designing a next generation system, ALLY, which combines an enhanced femtosecond laser with a phacoemulsification system in a single, compact cataract treatment system that is designed to allow surgeons to perform a femtosecond laser assisted cataract procedure in a single operating room using a single device. We expect this combination product will be a meaningful advancement and will provide significant administrative and financial benefit to a surgeon’s practice at a cost less than the cost of our current system.

Our current product portfolio consists of the LENSAR Laser System with Streamline IV and IntelliAxis and its associated consumable components. The consumable portion of the system consists of a disposable patient interface device, or PID, kit and a procedure license. Each procedure on each system requires the use of a PID kit. The PID kit includes a suction ring, vacuum filter and fluidic connection that are designed to facilitate placement of the laser while minimizing a patient’s discomfort, intraocular pressure and trauma to the retina and maintaining corneal integrity. The procedure license is downloaded onto the system as required or as purchased by the customer. The system will not perform a procedure without an active license. We offer licenses in a subscription package with minimum monthly obligations and the ability to increase procedure numbers as the practice grows to address occasional increases in demand. We believe this structure allows the surgeon to implement a budget while also providing us with a predictable revenue stream.

We are focused on continuous innovation and are currently developing our proprietary, next generation compact cataract treatment system, ALLY. ALLY is designed to combine our existing femtosecond laser technology with enhanced capabilities and a phacoemulsification system into a single unit and allow surgeons to perform each of the critical steps in a cataract procedure in a single operating room using this device. We anticipate submitting an application for 510(k) clearance to the U.S. Food and Drug Administration, or FDA, by the end of the first quarter of 2022 and to begin commercialization of ALLY by the end of 2022. If ALLY is cleared by the FDA, we believe its lower cost of goods and combined functions will help drive broader penetration for us into the overall cataract surgery market and could create a paradigm shift in the treatment of cataracts and management of astigmatism in cataract surgery.

We have built and are continuing to grow our commercial organization, which includes a direct sales force in the United States and distributors in Germany, China, South Korea and other targeted international geographies. We believe there is significant opportunity for us to expand our presence in these countries and other markets and regions. In the United States, we sell our products through a direct sales organization that, as of September 30, 2020, consisted of approximately 33 commercial professionals, including regional sales managers, clinical applications and outcomes specialists, field service, technology and customer support personnel. We currently manufacture our LENSAR Laser System at a facility in Orlando, Florida. We purchase custom and off-the-shelf components from a number of suppliers, including some single-source suppliers. We purchase the majority of our components and major assemblies through purchase orders with limited long-term supply agreements and generally do not maintain large volumes of finished goods. We strive to maintain enough inventory of our various component parts to avoid the impact of a potential short-term disruption in the supply.

Our revenue decreased from $8.1 million for the three months ended September 30, 2019 to $7.1 million for the three months ended September 30, 2020, representing a decline of 11.4%, primarily due to the impact of the COVID-19 pandemic as discussed below. Our net losses were $5.8 million and $4.8 million for the three months ended September 30, 2019 and September 30, 2020, respectively. Additionally, our installed base of LENSAR Laser Systems has increased from 207 as of December 31, 2019 to 219 as of September 30, 2020. Although our installed base of LENSAR Laser Systems increased, the decrease in revenue was primarily driven by the impact of the COVID-19 pandemic and a proportional decline in LENSAR Laser System sales relative to 2019.

Our revenue decreased from $22.1 million for the nine months ended September 30, 2019 to $18.1 million for the nine months ended September 30, 2020, representing a decline of 18%, primarily due to the impact of the COVID-19 pandemic. Our net losses were $12.2 million and $12.9 million for the nine months ended September 30, 2019 and September 30, 2020, respectively.

Factors to Consider

We operate in a highly competitive environment that involves a number of risks, some of which are beyond our control. We are subject to risks common to medical device companies, including risks inherent in:

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We cannot provide assurance that we will generate significant revenues or achieve and sustain profitability in the future. In addition, we can provide no assurance that we will have sufficient funding to meet our future capital requirements.

Our revenues and operating expenses are also difficult to predict and depend on several factors, including the level of ongoing research and development requirements necessary to complete development of our ALLY laser system, the number of laser systems we manufacture, sell, and lease on an annual basis, the availability of capital and direction from regulatory agencies, which are difficult to predict. We may be able to control the timing and level of research and development and selling, general and administrative expenses, but many of these expenditures will occur irrespective of our actions due to contractually committed activities and payments.

On March 11, 2020, the World Health Organization declared a global pandemic, as the outbreak of a novel strain of coronavirus spread throughout the world. The outbreak of COVID-19 has significantly disrupted our business operations and adversely impacted our business, as non-essential medical procedures, including cataract surgeries, were suspended or significantly decreased in many geographic areas. Actions taken to mitigate coronavirus have had, and are expected to continue to have, an adverse impact on the geographical areas in which we operate, and we are making adjustments intended to assist in protecting the safety of our employees and communities while continuing our business activities where possible and legally permitted. To date, implementation of these measures has not required material expenditures, but the suspension of non-essential medical services has significantly impacted our revenues and cash flows as well as increasing our inventories, and the pandemic continues to disrupt our commercial operations. During the second quarter of 2020, we made lease concessions to several customers related to the effects of the COVID-19 pandemic, which adversely impacted revenue recognized during the period. In return for these concessions, the related contracts were extended by the same number of months waived. We have also experienced minor supply chain disruptions as a result of COVID-19. We are continuing to monitor developments with respect to the outbreak and its potential impacts on our operations and those of our employees, distributors, partners, suppliers, and regulators.

As a result of these and other factors, our historical results are not necessarily indicative of future performance, and any interim results we present are not indicative of the results that may be expected for the full fiscal year.

Components of Our Results of Operations

Revenue

Total revenue comprises product revenue, service revenue and lease revenue. We derive product revenue from the sale of our laser systems and sales of our PID and procedure licenses to our surgeon customers and to our distributors outside the United States. A PID and procedure license, which may also be referred to as an application license, is required to perform each procedure using our laser system. A procedure license represents a one-time right to utilize the LENSAR Laser System surgical application in connection with a surgery procedure. Service revenue is derived from the sale of extended warranties for our laser systems that provide additional maintenance and service beyond our standard limited warranty. In some situations, we lease our laser systems to surgeons, primarily through non-cancellable leases with a fixed lease payment. We consider all components of our revenue to be recurring source revenue, with the exception of sales of our LENSAR laser systems. For the three and nine month periods ended September 30, 2020, approximately 82% and 87% of our revenue was attributable to recurring sources, compared to 72% and 78% for the three and nine month periods ended September 30, 2019.

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Cost of Revenue

Total cost of revenue comprises cost of product revenue, cost of lease revenue and cost of service revenue.

Cost of product revenue primarily consists of the raw materials used in the manufacture of our products, plant and equipment overhead, labor and stock-based compensation costs, packaging costs, depreciation expense, freight and other related costs, which include shipping, inspection and excess and obsolete inventory charges. Cost of lease revenue primarily consists of depreciation expense associated with leased equipment and shipping costs associated with delivery of these systems. Cost of service revenue primarily consists of costs associated with providing maintenance services under the extended warranty contracts.

Selling, General and Administrative Expense

Our selling, general and administrative expenses consist primarily of personnel costs, such as salaries and wages, including stock-based compensation, and benefits, professional and legal fees, marketing, insurance, travel and other expenses.

We are continuing to grow our sales efforts in the United States. We expect our selling, general and administrative expenses to continue to increase in association with our planned growth. Additionally, if we receive regulatory clearance for ALLY, we anticipate additional increases in selling, general and administrative expenses as we prepare for and launch commercialization of ALLY. We also expect to incur additional expenses as a result of operating as a public company, including expenses necessary to comply with the rules and regulations applicable to companies listed on a national securities exchange and those of the SEC, as well as increased expenses for director and officer insurance, investor relations and professional services.

Research and Development Expense

Our research and development expenses consist primarily of engineering, product development, clinical studies to develop and support our products, personnel costs, such as salaries and wages, including stock-based compensation, regulatory expenses, and other costs associated with products and technologies that are in development. Currently, our research and development expense primarily consists of costs associated with the continued development of our next-generation laser system, ALLY, which is designed to combine our existing femtosecond laser technology with a phacoemulsification system into a compact cataract treatment system.

As we continue to advance the development of ALLY, we expect our research and development expenditures to increase from current levels, as we anticipate that the planned development of ALLY will consume significant capital resources.

Amortization of Intangible Assets

Intangible assets with finite useful lives consist primarily of acquired trademarks, acquired technology, and customer relationships. Acquired trademarks and acquired technology are amortized on a straight-line basis over their estimated useful lives, of 15 to 20 years. Customer relationships are amortized on a straight-line basis or a double declining basis over their estimated useful lives up to 20 years, based on the method that better represents the economic benefits to be obtained.

Interest Expense

Interest expense primarily consists of interest expense associated with the Series A Preferred Stock and a note payable to PDL. The Series A Preferred Stock is classified as a liability on our balance sheet and related dividends are recorded as interest expense using the effective interest method. In July 2020, we entered into a contribution and exchange agreement with PDL, whereby we issued to PDL a total of 2,806,244 shares of our common stock in exchange for the extinguishment of the $32.6 million, including accrued interest, we owed to PDL under the Credit Agreement. In July 2020, we issued to PDL a total of 3,414,825 shares of our common stock in exchange for the extinguishment of all 30,000 shares of our Series A Preferred Stock, including any accrued and unpaid dividends thereon. We currently do not have any shares of Series A Preferred Stock outstanding.

Seasonality

We have historically experienced seasonal variations in the sales and leases of our products, with our fourth quarter typically being the strongest and the third quarter being the slowest. We believe these seasonal variations are consistent across our industry.

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Results of Operations

Comparison of the Three and Nine Months Ended September 30, 2020 and 2019