STRATA Skin Sciences, Inc. - Quarter Report: 2018 June (Form 10-Q)

The number of shares outstanding of the issuer's common stock as of August 10, 2018 was 29,888,502 shares.

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STRATA Skin Sciences, Inc. (and its subsidiary) ("STRATA" or "we" or the "Company") is a medical technology company focused on the therapeutic and aesthetic dermatology market. STRATA sales include the following products: XTRAC ^® excimer laser and VTRAC ^® excimer lamp systems utilized in the treatment of psoriasis, vitiligo and various other skin conditions; and the STRATAPEN^® MicroSystem, a micropigmentation device.

The XTRAC is an ultraviolet light excimer laser system utilized to treat psoriasis, vitiligo and other skin diseases. The XTRAC received clearance from the United States Food and Drug Administration (the "FDA") in 2000. As of June 30, 2018, there were 746 XTRAC systems placed in dermatologists' offices in the United States under the Company's recurring revenue business model. The XTRAC systems deployed under the recurring revenue model generate revenue on a per procedure basis or include a fixed payment over an agreed upon period with a capped number of treatments, which if exceeded would incur additional fees. The per-procedure charge is inclusive of the use of the system and the services provided by the Company to the customer which includes system maintenance, and other services. The VTRAC Excimer Lamp system, offered in addition to the XTRAC system internationally, provides targeted therapeutic efficacy demonstrated by excimer technology with a lamp system.

Effective February 1, 2017, the Company entered into an exclusive OEM distribution agreement with Esthetic Education, LLC to be the exclusive marketer and seller of private label versions of the SkinStylus MicroSystem and associated parts under the name of STRATAPEN. This three-year agreement allows for two one-year extensions.

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The Company records co-pay reimbursements made to patients receiving laser treatments as a reduction of revenue. For the three and six months ended June 30, 2017 the Company reclassified such reimbursements in the amount of $232 and $407, respectively, from selling and marketing expenses to revenues.

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The fair value of cash and cash equivalents are based on their respective demand value, which are equal to the carrying value. The fair value of derivative warrant liabilities is estimated using option pricing models that are based on the fair value of the Company's common stock as well as assumptions for volatility, remaining expected life, and the risk-free interest rate. The derivative warrant liabilities are the only recurring Level 3 fair value measures. The carrying value of all other short-term monetary assets and liabilities is estimated to be approximate to their fair value due to the short-term nature of these instruments. As of June 30, 2018 and December 31, 2017, the Company assessed its long-term debt (including the current portion) and determined that the fair value of total debt approximated its book value due to the market rate on the debt .

Several of the warrants outstanding as of June 30, 2018 and 2017 have non-standard terms as they relate to a fundamental transaction and require a net-cash settlement upon change in control of the Company. All such warrants are classified as derivatives and are the Company's only recurring fair value measurement. These warrants have been recorded at their fair value using a binomial option pricing model and continue to be recorded at their respective fair value at each subsequent balance sheet date until such terms expire. See Note 10, Warrants, for additional discussion. The fair value of the derivatives was insignificant at June 30, 2018 and December 31, 2017, respectively.

Earnings Per Share

The Company calculates net loss per share in accordance with ASC 260, Earnings per Share. Under ASC 260, basic net loss per common share is calculated by dividing net income by the weighted-average number of common shares outstanding during the reporting period and excludes dilution for potentially dilutive securities. Diluted earnings per share gives effect to dilutive options, warrants and other potential common shares outstanding during the period.

The Company's Series C Preferred Shares are subordinate to all other securities at the same subordination level as common stock and they participate in all dividends and distributions declared or paid with respect to common stock of the Company, on an as-converted basis. Therefore, the Series C Preferred Shares meet the definition of common stock under ASC 260. Earnings per share is presented for each class of security meeting the definition of common stock. The net loss is allocated to each class of security meeting the definition of common stock based on their contractual terms.

The following table presents the calculation of basic and diluted net loss per share by each class of security for the three and six months ended June 30, 2018:

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For the three and six months ended June 30, 2018, diluted net loss per common share is equal to the basic net loss per common share since all potentially dilutive securities are anti-dilutive. The loss on the change in fair value of the warrant liability was considered when calculating the diluted earnings per share and was deemed to be antidilutive.

 

The weighted average of potential common stock equivalents outstanding during the six months ended June 30, 2018 and 2017 consist of common stock equivalents of senior secured convertible debentures, common stock purchase warrants, convertible preferred stock, restricted stock units and common stock options, which are summarized as follows:

 

		Three Months Ended June 30,				Six Months Ended June 30,
		2018		2017		2018		2017
Common stock equivalents of convertible debentures		-		9,188,838		-		9,197,813
Common stock purchase warrants		2,396,721		2,406,625		2,401,646		2,406,625
Common stock equivalents of convertible preferred stock		9,608,625		336,243		11,485,730		401,676
Restricted stock units		17,028		-		17,028		-
Common stock options		3,037,796		867,414		1,962,933		882,787
Total		15,060,170		12,799,120		15,867,337		12,888,901

 

Adoption of New Accounting Standards

Effective January 1, 2018, the Company adopted Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers (Topic 606) using the modified retrospective method with a cumulative adjustment that increased its accumulated deficit and deferred revenue by approximately $234 as of January 1, 2018. The cumulative adjustment was related to the promise to provide service type warranties related to sales of dermatology procedures equipment. A portion of the transaction price of equipment sold with these service type warranties is allocated to such warranties based on their stand-alone selling price, and the Company now recognizes revenue from these service type warranties ratably over the warranty term. The method used to estimate stand-alone selling price is the price observed in transactions where the customer is charged a discrete price for the extended warranty.

Other than the above change related to warranties, the adoption of this standard did not have an impact on the Company's results of operations for the three and six months ended June 30, 2018. The impact from adopting this standard on the Company's statement of operations and comprehensive loss for the three and six months ended June 30, 2018 is as follows:

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In February 2016, the FASB issued ASU 2016-02: Leases (Topic 842, as amended). The guidance introduces a lessee model that results in most leases impacting the balance sheet. Under ASU 2016-02, lessees will be required to recognize, for all leases with terms longer than 12 months, at the commencement date of the lease, a lease liability, which is a lessee's obligation to make lease payments arising from a lease measured on a discounted basis, and a right-to-use asset, which is an asset that represents the lessee's right to use or control the use of a specified asset for the lease term. Leases will be classified as either finance or operating, with classification affecting the pattern of expense recognition. Also, the new standard aligns many of the underlying principles of the new lessor model with those in ASC 606, the FASB's new revenue recognition model. The update is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. While we continue to evaluate the effect of adopting this guidance on our consolidated financial statements and related disclosures, including the use of optional practical expedients, we expect our operating leases will be subject to the new standard. We will recognize right-of-use assets and operating lease liabilities on our consolidated balance sheets upon adoption, which will increase our total assets and liabilities. With regard to the Company's revenue from short-term leases, we do not expect the new standard to have a material impact on our consolidated financial statements.

 

Note 2

Equity Financing and Liquidity

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On March 30, 2018 we entered into a Stock Purchase Agreement (the "Accelmed SPA") and a Registration Rights Agreement with Accelmed Growth Partners L.P. ("Accelmed") investing $13,000 into the Company at a price per share of $1.08; upon closing Accelmed received 12,037,037 shares of our common stock.

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In connection with the proposed Accelmed investment, we entered into two separate stock purchase agreements on March 30, 2018, each for approximately $1,000 with our current shareholders, Broadfin Capital ("Broadfin") and Sabby Management ("Sabby"). Upon closing of these transactions, each of Sabby and Broadfin received 925,926 shares of our common stock at a price per share of $1.08.

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Two separate subscription agreements were also executed on March 30, 2018 in connection with the Accelmed investment: (i) a subscription agreement with Gohan Investments, Ltd. for $1,000 to purchase 925,926 shares of our common stock at $1.08 per share; and (ii) a subscription agreement with Dr. Dolev Rafaeli, the new CEO of the Company effective May 29, 2018, for $1,000 to purchase 925,926 shares of our common stock at $1.08 per share.

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Contract assets primarily relate to the Company's rights to consideration for work completed in relation to its services performed but not billed at the reporting date. The contract assets are transferred to receivables when the rights become unconditional. Currently, the Company does not have any contract assets which have not transferred to a receivable. Contract liabilities primarily relate to extended warranties where we have received payments but we have not yet satisfied the related performance obligations. The advance consideration received from customers for the services is a contract liability until services are provided to the customer. The $110 of short-term contract liabilities is presented as deferred revenues on the Condensed Consolidated Balance Sheets, and the $162 of long-term contract liabilities is presented within Other Liabilities. For the three and six months ended June 30, 2018, $13 and $20, respectively, was recognized as revenue from amounts classified as contract liabilities (i.e. deferred revenues) as of January 1, 2018.

The following table presents the Company's revenue disaggregated geographical region for the three and six months ended June 30, 2018. Domestic refers to revenue from customers based in the United States, and substantially all foreign revenue is derived from dermatology procedures equipment sales to the Company's international master distributor for physicians based in Asia.

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Related amortization expense was $401and $560 for the three months ended June 30, 2018 and 2017, respectively and $829 and $1,014 for the six months ended June 30, 2018 and 2017, respectively.

In the three months ended March 31, 2018, the Company wrote off distribution rights of $286 and accumulated amortization of $60 related to the discontinuance of the Nordlys product. The net value written off of $226 was recorded in selling and marketing expense. In the three months ended June 30, 2018, the Company wrote off distribution liabilities of $237 as a result of the termination of the agreement on May 31, 2018. The net value written off of $11 was recorded in selling and marketing expense for the six months ended June 30, 2018. (See Note 1)

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Included in accrued sales and other taxes are certain estimated sales and use taxes and related penalties and interest to taxing authorities. The Company has been subject to audits performed by the taxing authorities. The Company uses estimates when accruing its sales and use tax liability, including interest and penalties. All of the Company's tax positions are subject to audit. While the Company believes all of its estimates and assumptions are reasonable and will be sustained upon audit, actual liabilities and credits may differ significantly. The Company believes its accruals cover all probable payments relating to sales and use taxes.

On December 30, 2015, the Company entered into a $12,000 credit facility pursuant to a Credit and Security Agreement (the "Credit Agreement") and related financing documents with MidCap Financial Trust ("MidCap") and the lenders listed therein. Under the Credit Agreement, the credit facility may be drawn down in two tranches, the first of which was drawn for $10,500 on December 30, 2015. The proceeds of this first tranche were used to repay $10,000 principal amount of short-term senior secured promissory notes, plus associated interest, loan fees and expenses. The second tranche was drawn for $1,500 on January 29, 2016. The maturity date of the credit facility is December 1, 2020. The Company's obligations under the credit facility are secured by a first priority lien on all of the Company's assets. This credit facility includes both financial and non-financial covenants, including a minimum net revenue covenant. On November 10, 2017, the minimum net revenue covenant was amended prospectively. Additionally on November 10, 2017, the Company entered into an amendment to modify the principal payments including a period of six months where there are no principal payments due. The interest rate on the credit facility was one month LIBOR plus 8.25%, subject to a LIBOR floor of 0.5%.

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On March 26, 2018 we entered into a Third Amendment to the Credit Agreement with MidCap. For the period beginning on the closing date of the loan and ending on January 31, 2018, the gross revenue in accordance with GAAP for the twelve-month period ending on the last day of the most recently completed calendar month was amended to be less than the minimum amount on the Covenant Schedule, as defined in the Credit Agreement. The Amendment waives the event of default related to the revenue covenant for period ending February 2018. The Amendment also amends the monthly net revenue covenant for March and April 2018.

On May 29, 2018, we entered into a Fourth Amendment to Credit Agreement (the "Amendment"), pursuant to which the Company repaid $3.0 million in principal of the existing $10.6 million credit facility established with MidCap in 2015. The terms of the credit facility have been amended to impose less restrictive covenants and lower prepayment and exit fees for the Company. The Amendment modified the principal payments including a period of 18 months where there are no principal payments due. The interest rate on the credit facility is 7.25%. The Company was in compliance with all covenants as of June 30, 2018.

These amendments have been accounted for as debt modifications as the present value of the cash flows changed by less than 10%.

The following table summarizes the future payments that the Company is obligated to make for the long-term debt for the future periods:

The total outstanding convertible debentures was exchanged for convertible Preferred C stock on September 20, 2017, thus there was no remaining outstanding balance as of June 30, 2018 or December 31, 2017.

Total interest expense related to these convertible debentures was $0 and $16 for the three months ended June 30, 2018 and 2017, and $0 and $1,006 for the six months ended June 30, 2018 and 2017, respectively.

Note 10

Warrants:

The Company accounts for warrants that require net cash settlement upon change of control of the Company as liabilities instead of equity. Currently there are warrants to purchase 403,090 shares of common stock with an exercise price of $3.75 per share and they expire between February 5, 2019 and April 30, 2019. The fair value of these derivatives is insignificant as of June 30, 2018 and December 31, 2017. The change in fair value of these derivatives was recorded as $23 of other expense and $128 of other income for the three months ended June 30, 2018 and 2017, and $22 and $4 in other expense for the six months ended June 30, 2018 and 2017 respectively.

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At June 30, 2018, the Company had options to purchase 4,236,264 shares of common stock outstanding with a weighted-average exercise price of $2.06. As of June 30, 2018, options to purchase 684,090 shares are vested and exercisable.

On March 30, 2018, the Company issued options to purchase 1,557,628 shares of common stock to its then Interim Chief Executive Officer with a strike price of $1.12 per share. The options vest over three years and expire ten years from the date of grant. The aggregate fair value of the options granted was $950.

On May 23, 2018, the Company issued options to purchase 1,413,249 shares of common stock to its Chief Executive Officer with a strike price of $1.66 per share. The options vest over three years and expire ten years from the date of grant. The aggregate fair value of the options granted was $1,110.

There were additional grants made to management during the quarter totaling 800,000 at strike prices ranging from $1.66 to $1.93. The options vest over three years and expire ten years from the date of grant. The aggregate fair value of the options granted was $801.

In connection with the closing of the Financing, there were changes to the board of directors and the Company issued initial grants to new members as well as grants to all members as compensation. In total, the Company  granted 140,097 restricted stock units to the board members at a strike price of $2.07. The restricted stock units vest quarterly over twelve months and expire ten years from the date of grant. The aggregate fair value of the restricted stock units granted was $290.

Stock-based compensation expense, which is included in general and administrative expense, for the three and six months ended June 30, 2018 was $184 and $203, respectively. For the three and six months ended June 30, 2017 stock based compensation was $21 and $73, respectively. As of June 30, 2018 there was $3,194 in unrecognized compensation expense, which will be recognized over a weighted average period of 1.5 years. There are 1,151,021 options available for issuance as of June 30, 2018.

Note 13

Income Taxes:

The Company accounts for income taxes using the asset and liability method for deferred income taxes. The provision for income taxes includes federal, state and local income taxes currently payable and deferred taxes resulting from temporary differences between the financial statement and tax bases of assets and liabilities. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.

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Income tax expense of $40 and $80 for the three and six months ended June 30, 2018 and $73 and $143 for the three and six months ended June 30, 2017, respectively, was comprised of the change in deferred tax liability related to goodwill. Goodwill is an amortizing asset according to tax regulations. This generates a deferred tax liability that is not used to offset deferred tax assets for valuation allowance considerations.

The Company has experienced certain ownership changes, which under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended, result in annual limitations on the Company's ability to utilize its net operating losses in the future.  Although the Company has not performed a Section 382 study, any limitation of its pre-change net operating loss carryforwards that would result in a reduction of its deferred tax asset would also have an equal and offsetting adjustment to the valuation allowance.

Note 14

Business Segments:

The Company organized its business into two operating segments to better align its organization based upon the Company's management structure, products and services offered, markets served and types of customers, as follows: The Dermatology Recurring Procedures segment derives its revenues from the XTRAC procedures performed by dermatologists. The Dermatology Procedures Equipment segment generates revenues from the sale of equipment, such as lasers and lamp products. The Dermatology Imaging segment generated revenues from the sale and usage of imaging devices. The Company has announced that it will no longer support the imaging devices effective September 30, 2017 thus there will be minimal continuing revenues for this segment. Management reviews financial information presented on an operating segment basis for the purposes of making certain operating decisions and assessing financial performance.

Unallocated operating expenses include costs that are not specific to a particular segment but are general to the group; included are expenses incurred for administrative and accounting staff, general liability and other insurance, professional fees and other similar corporate expenses. Interest expense and other income (expense), net are also not allocated to the operating segments.

The following tables reflect results of operations from our business segments for the periods indicated below:

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For the three and six months ended June 30, 2017, revenues from sales to GlobalMed Technologies were $1,635 and $2,713, or 18.8% and 17.0%, of total revenues for such period, respectively. At June 30, 2017, the accounts receivable balance from GlobalMed Technologies was $681, or 19.1%, of total net accounts receivable.

No other customer represented more than 10% of total company revenues for the three and six months ended June 30, 2018 and 2017. No other customer represented more than 10% of total accounts receivable as of June 30, 2018 and 2017.

Note 16

Related Parties:

On March 30, 2018, in connection with the Financing, the Company entered into the Broadfin SPA and the Sabby SPA, each for approximately $1,000 with our current shareholders, Broadfin and Sabby. Upon closing of the Financing, each of Sabby and Broadfin received 925,926 shares of our common stock at a price per share of $1.08. In addition, the Company also entered into the Dolev Subscription Agreement with Dr. Dolev Rafaeli, our Chief Executive Officer and Director for $1,000 to purchase 925,926 shares of our common stock at $1.08 per share. See Note 2 for more information on the Financing.

 

On June 22, 2015, the Company entered into a securities purchase agreement with the Purchasers, including certain funds managed by Sabby Management, LLC and Broadfin Capital LLC (existing Company shareholders), in connection with a private placement. The Purchasers were issued Warrants to purchase an aggregate of 0.6 million shares of common stock, having an exercise price of $3.75 per share. We also issued $32.5 million aggregate principal amount of Debentures that, subject to certain ownership limitations and stockholder approval conditions, were convertible into 8,666,668 shares of common stock at an initial conversion price of $3.75 per share. The Debentures were bearing interest at the rate of 2.25% per year, and, unless previously converted, were to mature on the five-year anniversary of the date of issuance. Refer to Note 9 for information on the interest expense relating to the Debentures. On September 30, 2015, the Company repriced outstanding Warrants held by certain investors to reduce the exercise price to $3.75 per share.

On June 6, 2017, the Company entered into a Securities Exchange Agreement (the "Agreement") with the holders of its 2.25% Senior Series A Secured Convertible Debentures due June 30, 2021 and 4% Senior Secured Convertible Debentures due July 30, 2021, pursuant to which the holders have agreed to exchange all of such outstanding debentures into shares of newly created Series C Convertible Preferred Stock. The stockholders approved the exchange at the stockholders' meeting held on September 14, 2017. The closing of the exchange was effective on September 20, 2017 and $40,465 of principal was exchanged for 40,482 shares of Series C Preferred Stock. In accordance with ASC Topic 470, Debt, the aforementioned exchange was treated as an extinguishment of debt.

On November 4, 2015, the Company entered into consulting agreements with two of its directors, Jeffrey F. O'Donnell, Sr. and Samuel E. Navarro, the terms of which were the same. Under the terms of their respective agreements, each director agreed to provide strategic support, advice and guidance to the Company and its management team in connection with the integration and operation of the expanded business, investor relations and internal and external business development activities. The respective consultant made himself available to the Company's President and Chief Executive Officer and the management team on request at mutually convenient times and reported to the Board of Directors quarterly and otherwise when requested by the Board. The agreements had been extended through June 30 and December 31, 2017 for Mr. Navarro and Mr. O'Donnell, respectively. The directors were each to be paid an up-front fee of $40 for advice and services rendered prior to the date of the agreement, including advice related to the acquisition of the XTRAC and VTRAC assets and the structuring of the financing for that acquisition, a retainer of $10 per month, commencing November 10, 2015 and continuing on the tenth day of each month through the expiration of their respective agreements, and reimbursement of pre-approved, out-of-pocket expenses. The agreements expired per their terms on June 30, 2017 and December 31, 2017, respectively, and no extensions or renewals of the agreement were entered into.

During 2017, Modevity LLC ("Modevity"), the developer of the ARALOC Secure Content Distribution Platform, a software system for sharing proprietary and / or confidential content files over the internet and allowing its users to collaborate securely from any mobile or desktop device, has provided certain consulting services to the Company advising on the development of our digital media and marketing initiatives, including providing assistance in our first limited test of targeted advertising using Facebook. Our Board member, James Coyne, has been the Chief Executive Officer of Modevity since helping to found the company in April 2004. To date, Modevity has provided this assistance without charge to the Company. Independent of these services provided by Modevity, in November 2017 the Company entered into an agreement with Olympic Media, a company founded by Ryan Coyne, the son of James Coyne, to create and execute a focused tactical plan to leverage new and existing digital assets across social and digital platforms to drive psoriasis and vitiligo sufferers to the Company's website and call center for conversion to new patient appointments. The agreement with Olympic Media provides for no minimum payments or other financial commitments and is terminable by either party without penalty on ten days written notice. During the three months ended March 31, 2018, the Company incurred $13 of expense related to Olympic Media. James Coyne has no financial interest in Olympic Media.

Note 17

Subsequent Event:

In July 2018, the Company issued 153,004 shares in connection with certain contingencies as part of the Stock Purchase Agreements in connection with the Financing that closed on May 29, 2018 (See Note 1). The Company included these shares in Common Stock Issuable as of June 30, 2018. There are additional contingencies included in the SPA's that the Company has determined are not probable or estimable at this time.

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STRATA Skin Sciences, Inc. ("STRATA" or "we" or the "Company") is a medical technology company focused on the therapeutic and aesthetic dermatology market. STRATA sales include the following products: XTRAC^® excimer laser and VTRAC^® excimer lamp systems utilized in the treatment of psoriasis, vitiligo and various other skin conditions; and the STRATAPEN^® MicroSystems, a micropigmentation device.

The XTRAC device is utilized to treat psoriasis, vitiligo and other skin diseases. The XTRAC device received FDA clearance in 2000 and has since become a widely recognized treatment among dermatologists. The system delivers targeted 308um ultraviolet light to affected areas of skin, leading to psoriasis clearing and vitiligo repigmentation, following a series of treatments. As of June 30, 2018, there were 746 XTRAC systems placed in dermatologists' offices in the United States under our dermatology recurring procedure model, down from 795 at the end of June 30, 2017. Under the dermatology recurring procedure model, the XTRAC system is placed in a physician's office and fees are charged on a per procedure basis or a fee is charged on a periodic basis not to exceed an agreed upon number of procedures. The XTRAC system's use for psoriasis is covered by nearly all major insurance companies, including Medicare. The VTRAC Excimer Lamp system, offered internationally in addition to the XTRAC, provides targeted therapeutic efficacy demonstrated by excimer technology with the simplicity of design and reliability of a lamp system. There are approximately 7.5 million people in the United States and up to 125 million people worldwide suffering from psoriasis, and 1% to 2% of the world's population suffers from vitiligo. In 2017, over 335,000 XTRAC laser treatments were performed on approximately 21,000 patients in the United States.

Effective February 1, 2017, we entered into an exclusive OEM distribution agreement with Esthetic Education, LLC to be the exclusive marketer and seller of private label versions of the SkinStylus MicroSystem and associated parts under the name of STRATAPEN. This three-year agreement allows for two one year extensions.

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Recent Developments

Equity Financing

 

 

 

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Sales and Marketing

As of June 30, 2018, our sales and marketing personnel consisted of 46 full-time positions, inclusive of a direct sales organization as well as an in-house call center staffed with patient advocates and a reimbursement group that provides necessary insurance information to our physician partners and their patients.

Critical Accounting Policies and Estimates

There have been no changes to our critical accounting policies in the three months ended June 30, 2018 except for the adoption of the new revenue recognition standard as discussed under Adoption of New Accounting Standards within Note 1 to the condensed consolidated financial statements. Critical accounting policies and the significant estimates made in accordance with such policies are regularly discussed with our Audit Committee. Those policies are discussed under "Critical Accounting Policies" in our "Management's Discussion and Analysis of Financial Condition and Results of Operations" included in Item 7, as well as in our consolidated financial statements and the footnotes thereto for the fiscal year ended December 31, 2017, as filed with the SEC with our Annual Report on Form 10-K filed on April 2, 2018.

Revenues

The following table presents revenues from our two segments for the periods indicated below

Recognized treatment revenue for the three months ended June 30, 2018 was $5,167, which we estimate is approximately 76,000 treatments, with prices between $65 to $95 per treatment compared to recognized treatment revenue for the three months ended June 30, 2017 of $5,971, which we estimate is approximately 89,000 treatments, with prices between $65 to $95 per treatment. Recognized treatment revenue for the six months ended June 30, 2018 was $9,665, which approximates 143,000 treatments, with prices between $65 to $95 per treatment compared to recognized treatment revenue for the six months ended June 30, 2017 of $11,527, which approximates 166,000 treatments, with prices between $65 to $95 per treatment. Increases in procedures are dependent upon building market acceptance through marketing programs with our physician partners and their patients to show that the XTRAC procedures will be of clinical benefit and will be generally reimbursed by insurers. We believe that several factors have had a negative impact  on the prescribed use of XTRAC treatments for psoriasis and vitiligo patients. Specifically, we believe that there is a lack of awareness of the positive effects of XTRAC treatments among both sufferers and providers; and the treatment regimen which can sometimes require up to 12 or more treatments has limited XTRAC use to certain patient populations. Therefore, we have initiated a direct to patient program for XTRAC advertising in the United States, targeting psoriasis and vitiligo patients through a variety of media including television and radio; and through our use of social media such as Facebook and Twitter. We monitor the results of our advertising expenditures in this area to reach the more than 10 million patients in the United States afflicted with these diseases. In the last four quarters, in an effort to conserve cash, we reduced the amount spent on the direct to patient programs. This caused a decrease in the patient traffic to our dermatologist partner clinics, which, in turn, caused a decline in recurring patient revenues. With the equity financing completed in May 2018, we expect to increase spending in the direct to patient programs to drive patients to our partner clinics to increase recurring revenue. The increase in these programs precedes the recurring revenue as there is a lag between advertising and patients receiving treatment which we estimated to be three to six months.

Revenues from Dermatology Recurring Procedures are recognized over the contract term, which equates to the usage period of the agreed upon number of treatments, as the treatments are being used. As of June 30, 2018 and 2017, we deferred net revenues of $188 and $278, respectively which will be recognized as revenue over the remaining contract term.

For the three months ended June 30, 2018 dermatology equipment revenues were $2,366. Internationally, we sold 25 systems for the three months ended June 30, 2018, (24 XTRAC and 1 VTRAC ). Domestically, we sold 3 XTRAC systems for the three months ended June 30, 2018. For the three months ended June 30, 2017 dermatology equipment revenues were $2,500. Internationally, we sold 21 systems for the three months ended June 30, 2017 (18 XTRAC and 3 VTRAC). This segment of our revenue may be impacted by tariffs currently planned to be imposed at the end of August 2018.

For the six months ended June 30, 2018 dermatology equipment revenues were $4,334. Internationally, we sold 44 systems for the six months ended June 30, 2018, (37 XTRAC and 7 VTRAC ). Domestically, we sold 8 XTRAC systems for the six months ended June 30, 2018. For the six months ended June 30, 2017 dermatology equipment revenues were $4,041. Internationally, we sold 30 systems for the six months ended June 30, 2017, (26 XTRAC and 4 VTRAC).

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The primary reason for the change in gross profit for the three and six months ended June 30, 2018 for dermatology recurring revenue, compared to the same periods in 2017, is due to a lower number of treatments in 2018 as a result of lower advertising spend. Incremental treatments delivered on existing equipment incur negligible incremental costs, so increases and/or decreases in those treatments have an impact on gross margin.

The primary reason for the change in gross profit for the three and six months ended June 30, 2018 for dermatology procedures equipment, compared to the same period in 2017, was the write off of the Nordlys inventory and fixed assets as we will no longer be selling this product line. Therefore, the Company wrote the assets down to their net realizable value. In addition, the geographic mix unfavorably impacted the margins as we sold $657 less in domestic sales in the second quarter of 2018 as compared to the same period in 2017. Generally the average selling prices are higher domestically than internationally.

 

Engineering and Product Development

Engineering and product development expenses for the three months ended June 30, 2018 decreased to $269 from $423 for the three months ended June 30, 2017. The decrease was primarily due to employee severance costs incurred during the three months ended June 30, 2017 associated with discontinuing research and development efforts for dermatology imaging devices. Engineering and product development expenses for the six months ended June 30, 2018 decreased to $607 from $898 for the six months ended June 30, 2017. The decrease relates to lower compensation and project costs in 2018, associated with discontinuing research and development efforts for dermatology imaging devices.

Selling and Marketing Expenses

For the three months ended June 30, 2018, selling and marketing expenses decreased to $2,378 from $2,846 for the three months ended June 30, 2017. The decrease was primarily related to the planned reduction in expense in television and radio media over to more of an internet and social media campaign, and an offset by the write off of distributor liability of $236 associated with the exit from selling the Nordlys product line. For the six months ended June 30, 2018 selling and marketing expenses decreased to $5,249 from $5,821 for the six months ended June 30, 2017. The decrease was primarily related to the planned reduction in expense in television and radio media over to more of an internet and social media campaign. The credit from the write off of the distribution rights in the first quarter of 2018. The Company expects to carefully manage increase to the direct to consumer advertising in the coming quarters.

 

 

General and Administrative Expenses