ENTEROMEDICSRESHAPE LIFESCIENCES INC.

FORM 10-K

TABLE OF CONTENTS

Registered Trademarks and Trademark Applications:In the United States we have registered trademarks for vBLOC®LAP-BAND®, ENTEROMEDICS®LAP-BAND AP®, LAP BAND SYSTEM®, RAPIDPORT®, RESHAPE® and MAESTRO®RESHAPE MEDICAL®, each registered with the United States Patent and Trademark Office, and trademark applications for vBLOC POWER TO CHOOSERESHAPE VEST, and vBLOC POWER TO CHOOSE AND DESIGN.RESHAPE LIFESCIENCES.  In addition, some or all of the marks vBLOC, ENTEROMEDICS, MAESTRO, MAESTROLAP-BAND, LAP-BAND AP, LAP BAND SYSTEM, ORCHESTRATING OBESITY SOLUTIONS, vBLOC POWER TO CHOOSERAPIDPORT, RESHAPE, RESHAPE MEDICAL, RESHAPE VEST, and vBLOC POWER TO CHOOSE AND DESIGNRESHAPE LIFESCIENCES are the subject of either a trademark registration or an application for registration in Australia, Brazil, China,Canada, the European Community, India, Kuwait, Mexico, Saudi Arabia, SwitzerlandSouth Korea, and the United Arab Emirates.  We believe that we have common law trademark rights to RESHAPE VEST.  This Annual Report on Form 10-K contains other trade names and trademarks and service marks of EnteroMedicsReShape Lifesciences and of othercompanies.

PART I. 

ITEM 1.BUSINESS

This Annual Report on Form 10-K contains forward-looking statements. These forward-looking statements are based on our current expectations about our business and industry. In some cases, these statements may be identified by terminology such as “may,” “will,” “should,” “expects,” “could,” “intends,” “might,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,” or “continue,” or the negative of such terms and other comparable terminology. These statements involve known and unknown risks and uncertainties that may cause our results, levels of activity, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to such differences include, among others, those discussed in this report in Item 1A “Risk Factors.” Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.

Our Company

We areThe Company is a developer of minimally invasive medical devices that advance bariatric surgery to treat obesity and metabolic diseases. The Company’s current portfolio includes the LAP-BAND® Adjustable Gastric Banding System and the ReShape VestTM, an investigational device, companyto help treat more patients with approvalsobesity. Our vision is to commercially launch our product, the vBloc Neuromodulation System (vBloc System).  We arebe recognized as a leading medical technology company focused on the design, development and developmentcommercialization of devices that use neuroblockingtransformative technology to treat obesity and metabolic diseases and other gastrointestinal disorders. diseases.

Our proprietary neuroblocking technology,Product Portfolio

Lap-Band System

The Lap-Band System, which we refer to as vBloc Therapy,acquired from Apollo Endosurgery, Inc. (“Apollo”), in December 2018, is designed to intermittently block the vagus nerve using high frequency, low energy, electrical impulses. We have a limited operating historyprovide minimally invasive long-term treatment of severe obesity and only recently received U.S. Food and Drug Administration (FDA) approvalis an alternative to sell our product in the United States. In addition, we have regulatory approval to sell our product in the European Economic Area and other countries that recognize the European CE Mark and do not have any other source of revenue. We were incorporated in Minnesota on December 19, 2002 and later reincorporated in Delaware on July 22, 2004. We have devoted substantially all of our resources to the development and commercialization of the vBloc System, which was formerly knownmore invasive surgical stapling procedures such as the Maestrogastric bypass or vBloc Rechargeable System.

sleeve gastrectomy. The vBlocLap-Band System our initial product, uses vBloc Therapy to limitis an adjustable saline-filled silicone band that is laparoscopically placed around the expansionupper part of the stomach help control hunger sensations between meals, reducethrough a small incision, creating a small pouch at the frequencytop of the stomach, which slows the passage of food and intensitycreates a sensation of stomach contractionsfullness. The procedure can normally be performed as an outpatient procedure, where the patient is able to go home the day of the procedure without the need for an overnight hospital stay.

The Lap-Band System has been in use in Europe since 1993 and produce a feeling of early and prolonged fullness. We believereceived the vBloc System offers obese patients a minimally-invasive treatment that can resultCE mark in significant, durable and sustained weight loss. We believe that our vBloc System allows bariatric surgeons to offer a new option to obese patients who are concerned about the risks and complications associated with currently available anatomy-altering, restrictive or malabsorptive surgical procedures.

We received1997. FDA approval on January 14, 2015 for vBloc Therapy, delivered via the vBloc System, for the treatment of adultLap-Band System in the U.S. was obtained in 2001 and the Lap-Band System has been approved in many countries around the world. More than 860,000 Lap-Band Systems have been distributed worldwide.

The Lap-Band System was approved for use in the U.S. for patients with obesity who have a Body Mass Index (BMI)(“BMI”) greater than or equal to 40 or a BMI greater than or equal to 35 with one or more severe comorbid conditions. In 2011, the U.S. FDA granted approval for an expanded indication for the Lap-Band System to include patients with a BMI in the range of at least 4030 to 45 kg/m2,35 and with one or more comorbid conditions.

The Lap-Band System has been subject to more than 400 peer-reviewed publications and extensive real-world experience. Adjustable gastric banding using the Lap-Band System has been reported to be significantly safer than gastric bypass while statistically producing the same weight loss five years after surgery when accompanied by an appropriate post-operative follow-up and adjustment protocol. Studies have reported sustained resolution or improvement in type 2 diabetes, gastroesophageal reflux, obstructive sleep apnea, asthma, arthritis, hypertension and other pre-existing obesity related comorbidities following gastric banding. The gastric banding surgical procedure is generally reimbursed by most payors and insurance programs that cover bariatric surgery.

Benefits.  Lap-Band System offers the following benefits:

ReShape Vest

The ReShape Vest is an investigational, minimally invasive, laparoscopically implanted medical device being studied for weight loss in morbidly obese adults with a BMI of at least 3535. The device wraps around the stomach, emulating the effect of conventional weight loss surgery, and is intended to 39.9 kg/m2 with a related health condition such as high blood pressureenable gastric volume reduction. This device is designed to restrict the intake of food and provide the feeling of fullness without cutting or high cholesterol levels, and who have tried to lose weight in a supervised weight management program and failed within the past five years. In 2015 we began a controlled commercial launch at select surgical centers in the United States and had our first commercial sales. During 2015, we initiated a controlled expansion of our commercial operations and started the process of building a sales force. In January 2016, we hired new executives to oversee this expansion. Our direct sales force is supported by field clinical engineers who provide training, technical and other support services to our customers. Throughout 2016, our sales force called directly on key opinion leaders and bariatric surgeons at commercially-driven surgical centers that met our certification criteria.  Additionally, in 2016, through a distribution agreement with Academy Medical, LLC, U.S. Department of Veterans Affairs (VA) medical facilities now offer the vBloc System as a treatment option for veterans at little to no cost to veterans in accordance with their veteran healthcare benefits. We plan to build on these efforts in 2017 with self-pay and veteran focused direct-to-patient marketing, key opinion leader and center-specific partnering, and a multi-faceted reimbursement strategy. To date, we have relied on, and anticipate that we will continue to rely on, third-party manufacturers and suppliers for the productionpermanently removing portions of the vBloc System.stomach, or bypassing, any portion of the gastrointestinal tract. The implantation of the device mimics a traditional weight‑loss surgery without permanently altering the anatomy and may not require vitamin supplementation.

In 2016, we sold 62 units for $787,000 in revenue, and in 2015 we sold 24 units for $292,000 in revenue. We have incurred and expect to continue to incur significant sales and marketing expenses prior to recording sufficient revenue to offset these expenses.  Additionally, our selling, general and administrative expenses have increased since we commenced commercial operations, and we expect that they will continue to increase as we continue to build the infrastructure necessary to support our expanding commercial sales, operate as a public company and develop our

intellectual property portfolio. For these reasons, we expect to continue to incur operating losses for

In a small pilot study conducted outside the next several years. We have financed our operations to date principally through the sale of equity securities, debt financing and interest earned on cash investments.

Data from our ReCharge trial was used to support the premarket approval (PMA) application for the vBloc System, submitted to the FDA in June 2013. The ReCharge trial is a randomized, double-blind, sham-controlled, multicenter pivotal clinical trial testing the effectiveness and safety of vBloc Therapy utilizing our vBloc System. All patients in the trial received an implanted device and were randomized in a 2:1 allocation to treatment or sham control groups. The sham control group received a non-functional device during the trial period. All patients were expected to participate in a standard weight management counseling program. The primary endpoints of efficacy and safety were evaluated at 12 months. As announced, the ReCharge trial met its primary safety endpoint with a 3.7% serious adverse event rate. The safety profileUnited States, at 12 months, was further supported by positive cardiovascular signals includingReShape Vest patients demonstrated a 5.5 mmHg drop in systolic blood pressure, a 2.8 mmHg drop in diastolic blood pressure and a 3.6 bpm drop in average heart rate. 

Additionally, the trial demonstrated in the intent to treat (ITT) population (n=239) a clinically meaningful and statistically significantmean percent excess weight loss (EWL)(“%EWL”) of 24.4% (approximately 10%85% and a mean percent total body weight loss (TBL))of 30.2%, an average drop in HbA1c (Hemoglobin A1c) of 2.1 points, an average decrease of systolic blood pressure of 13mmHg, an average waist circumference reduction of 38 centimeters, or approximately 15 inches, and an average increase in HDL “good cholesterol” of 29 mg/dl.

Benefits.  The ReShape Vest, if approved for vBloc Therapy-treated patients, with 52.5% of patients achieving at least 20% EWL, although it did not meet its co-primary efficacy endpoints duesale, would allow us to higher than expectedoffer an additional weight loss levels insolution that emulates the sham control group. In the per protocol population, the trial demonstrated an EWLeffect of 26.3% for vBloc Therapy-treated patients, with 56.8% of patients achieving at least 20% EWL.  We subsequently announced that vBloc Therapy-treated patients were maintaining theirconventional weight loss at 18 months and 24 months with an EWL of 23.5% and 21.1%, respectively.surgery through a procedure that is minimally invasive. The trial’s positive safety profile also continued throughout this reported time period.

InReShape Vest potentially offers the ReCharge trial, two-thirds of vBloc Therapy-treated patients achieved at least 5% TBL at 12 months. According to the Centers for Disease Control and Prevention (CDC), 5% TBL can have significant health benefits on obesity related risk factors, or comorbidities, including reduction in blood pressure, improvements in Type 2 diabetes and reductions in triglycerides and cholesterol. Further analysis of our data at 12 months showed a meaningful impact on these comorbidities as noted in the below table showing the improvements seen at 10% TBL, the average weight loss in vBloc Therapy-treated patients.

following benefits:

hold promiseand can serve more of the overweight and obese population with our solutions and thereby help expand the addressable market for obesity.

Drive the Adoption of Our Portfolio through Obesity Therapy Experts and Patient Ambassadors

Our clinical development strategy is to collaborate closely with regulatory bodies, healthcare providers, obesity therapy experts and others involved in improving obesity-related comorbidities such asthe obesity management process, patients and their advocates and scientific experts. We have established relationships with obesity therapy experts and healthcare providers, including physicians and hospitals, and have identified Lap-Band patient ambassadors and we believe these individuals will be important in promoting patient awareness and gaining widespread adoption of the Lap-Band and the ReShape Vest.

Expand and Protect Our Intellectual Property Position

We believe that our issued patents and our patent applications encompass a broad platform of therapies focused on obesity, diabetes, hypertension and hypertension.other gastrointestinal disorders. We are conducting, or planintend to continue to pursue further intellectual property protection through U.S. and foreign patent applications.

Leverage our vBloc Technology for Other Disease States

We intend to continue to conduct further studiesresearch and development for other potential applications for our vBloc Therapy and believe we have a broad technology platform that will support the development of additional clinical applications and therapies for other metabolic and gastrointestinal disorders in each of these comorbiditiesaddition to assess vBloc Therapy’s potential in addressing multiple indications.obesity.

EnrollmentAlternative Weight Loss Solutions

If we are able to commercialize the ReShape Vest, we believe that we will be able to offer two distinct weight loss treatment solutions that may be selected by the physician depending on the severity of the VBLOC-DM2 ENABLE trial began in 2008. The VBLOC-DM2 ENABLE trial is designed to evaluatepatient’s BMI or condition. Together, the efficacyLap-Band and safetyReShape Vest provide a minimally-invasive continuum of vBloc Therapy on obese subjects as well as its effect on glucose regulation in approximately 30care for bariatric patients who are using the vBloc System. The trial is an international, open-label, prospective, multi-center study. At each designated trial endpoint the efficacy of vBloc Therapy is evaluated by measuring average percentage EWL, HbA1c (blood sugar), FPG (fasting plasma glucose), blood pressure, calorie intake, appetite and other endpoints at one week, one month, three, six, 12 and 18 months and longer. The following results were reported at 12 month intervals.

To date, no deaths related to our device or unanticipated adverse device effects have been reported during the VBLOC-DM2 ENABLE trial and the safety profile is similar to that seen in the other vBloc trials.

Caloric Intake Sub-study:    A sub-study, conducted as part of the VBLOC-DM2 ENABLE trial, evaluated 12-month satiety and calorie intake in 10 patients with Type 2 diabetes mellitus enrolled in the trial. Follow-up measures among patients enrolled in the sub-study included EWL, 7-day diet records assessed by a nutritionist, calorie calculations and visual analogue scale (VAS) questions to assess satiety by 7-day or 24-hour recall at the following time periods: baseline, 4 and 12 weeks and 6 and 12 months post device initiation. A validated program, Food Works™, was used to determine calorie and nutrition content. Results include:

their care providers.

Our Product

The vBloc System, our initial product, uses vBloc Therapy to limit the expansion of the stomach, help control hunger sensations between meals, reduce the frequency and intensity of stomach contractions and produce a feeling of early and prolonged fullness. We believe the vBloc System offers obese patients a minimally-invasive treatment that can result in significant, durable and sustained weight loss. We believe that our vBloc System allows laproscopically trained surgeons to offer a new option to obese patients who are concerned about the risks and complications associated with currently available anatomy-altering, restrictive or malabsorptive surgical procedures.

The vBloc System delivers vBloc Therapy via two small electrodes that are laparoscopically implanted and placed in contact with the trunks of the vagus nerve just above the junction between the esophagus and the stomach, near the diaphragm and connected to a neuroregulator, which is subcutaneously implanted. The vBloc System is powered by an internal rechargeable battery. The vBloc System is implanted by a laproscopically trained surgeon using a procedure that is typically performed within 60-90 minutes as an outpatient procedure. The physician activates the vBloc System after implantation. vBloc Therapy is then delivered intermittently through the neuroregulator each day as scheduled (recommended during the patient’s waking hours when food is consumed). The scheduled delivery of the intermittent pulses blocking the vagus nerve is customized for each patient’s weight loss and overall treatment objectives. The physician is able to download reports to monitor patient use and system performance information. This information is particularly useful to physicians to ensure that patients are properly using the system.

Our Market

The Obesity and Metabolic Disease Epidemic

Obesity is a disease that has been increasing at an alarming rate with significant medical repercussions and associated economic costs. Since 1980, the worldwide obesity rate has more than doubled, with about 13% of the world’s adult population now being obese. The World Health Organization (WHO)(“WHO”) currently estimates that as many as 600 million people worldwide are estimated to be obese and more than 1.92.1 billion adults, are estimated to be overweight. Being overweight or obese is also the fifth leading risk for global deaths, with approximately 3.4 million adults dying each year as a result.

According to the WHO, there are over 70 progressive obesity-related diseases and disorders associated with obesity, which are also known as comorbidities, including Type 2 diabetes, hypertension, infertility and certain cancers. Worldwide, 44%30% of the diabetes burden, 23%global population, are overweight. The global economic impact of the heart disease burdenobesity is approximately $2 trillion, or approximately 2.8% of global GDP. Healthcare costs for severely or morbidly obese adults are 81% higher than for healthy weight adults and between 7%obesity is responsible for 5% of deaths worldwide. We believe our products and 41% of certain cancer burdens are attributable to overweight and obesity.product candidates could address a $1.64 billion per year global surgical device market.

We believe that this epidemic will continue to grow worldwide given dietary trends in developed nations that favor highly processed sugars, larger meals and fattier foods, as well as increasingly sedentary lifestyles. Despite the growing obesity rate, increasing public interest in the obesity epidemic and significant medical repercussions and economic costs associated with obesity, there continues to be a significant unmet need for effective treatments.

The United States Market

Obesity has been identified by the U.S. Surgeon General as the fastest growing cause of disease and death in the United States.States, and according to a 2014 McKinsey Report is the leading cause of preventable death in the U.S. Currently, the Center for Disease Control (the CDC) estimatesit is estimated that 35.7% of U.S.approximately 160 million American adults (or approximately 73,000,000 people)are overweight or obese, 74 million American adults are overweight, 78 million American adults are obese having a BMI of 30 or higher. BMI is calculated by dividing a person’s weight in kilograms by the square of their height in meters.severely obese, and 24 million American adults are morbidly obese. It is estimated that if obesity rates stay consistent, 51% of the U.S. population will be obese by 2030. According to data from the U.S. Department of Health and Human Services, almost 80% of adults with a BMI above 30 have a co-morbidity,comorbidity, and almost 40% have two or more of these comorbidities. According to The Obesity Society and the CDC, obesity is associated with many significant weight-relatedweight‑related comorbidities including Type 2 diabetes, high blood-pressure,blood‑pressure, sleep apnea, certain cancers, high cholesterol, coronary artery disease, osteoarthritis and stroke. According to the American Cancer Society, 572,000 Americans die of

We believe that this epidemic will continue to grow worldwide given dietary trends in developed nations that favor highly processed sugars, larger meals and fattier foods, as well as increasingly sedentary lifestyles. Despite the growing obesity rate, increasing public interest in the obesity epidemic and significant medical repercussions and economic costs associated with obesity, there continues to be a significant unmet need for effective treatments.

Our Technology

vBloc Therapy is designed to block the gastrointestinal effects of the vagus nerve using high-frequency, low-energy electrical impulses to intermittently interrupt naturally occurring neural impulses on the vagus nerve between the brain and the digestive system. Our therapy controls hunger sensations between meals, limits the expansion of the stomach and reduces the frequency and intensity of stomach contractions, leading to earlier fullness. The resulting physiologic effects of vBloc Therapy produce a feeling of early and prolonged fullness following smaller meal portions. By intermittently blocking the vagus nerve and allowing it to return to full function between therapeutic episodes, our therapy limits the body’s natural tendency to circumvent the therapy, which can result in long-term weight loss.

We have designed our vBloc System to address a significant market opportunity that we believe exists for a patient-friendly, safe, effective, less-invasive and durable therapy that is intended to address the underlying causes of hunger and obesity. Our vBloc System offers each of the following benefits, which we believe could lead to the adoption of vBloc Therapy as the surgical therapy of choice for obesity and its comorbidities:

vBloc Therapy, delivered via our vBloc System, is intended to offer patients an effective, safe, outpatient solution that minimizes complications. It enables patients to lose weight and maintain long-term weight loss while enjoying a normal, healthy diet. We also believe that the vBloc System will appeal to physicians based on the inherent physiological approach of vBloc Therapy and its favorable safety profile.

Our Commercialization Strategy

Our goal is to establish vBloc Therapy, delivered via our vBloc System, as the leading obesity management solution. The key business strategies by which we intend to achieve these objectives include:

stimulators, acquired TransNeuronix, which sought to treat obesity by stimulating the smooth muscle of the stomach wall and nearby tissue. St. Jude Medical, Inc., through its acquisition of Advanced Neuromodulation Systems, is developing spinal cord stimulators. LivaNova PLC is developing vagus nerve stimulators to modulate epileptic seizures and other neurological disorders. Boston Scientific Corporation, through its Advanced Bionics division, is developing neurostimulation devices such as spinal cord stimulators and cochlear implants. Ethicon-Endo Surgery acquired LivaNova PLC’s patents and patent applications pertaining to vagus nerve stimulation for the treatment of obesity and two related comorbidities, diabetes and hypertension, in overweight patients.

We believe that the principal competitive factors in our market include:

Many of our competitors are larger than we are and are either publicly-traded or are divisions of publicly-traded companies, and they enjoy several competitive advantages over us, including:

As a result, we cannot assure you that we will be able to compete effectively against these companies or their products.

Market Opportunity

Given the limitations of behavioral modification, pharmaceutical therapy and traditional bariatric surgical approaches, we believe there is a substantial need for patient-friendly, safer, effective and durable solutions that:

Our Intellectual Property

In order to remain competitive, we must develop and maintain protection of the proprietary aspects of our technologies. We rely on a combination of patents, trademarks, trade secret laws and confidentiality and invention assignment agreements to protect our intellectual property rights. Our patent applications may not result in issued patents and our patents may not be sufficiently broad to protect our technology. Any patents issued to us may be challenged by third parties as being invalid or unenforceable, or third parties may independently develop similar or competing technology that does not infringe our patents. The laws of certain foreign countries do not protect our intellectual property rights to the same extent as do the laws of the United States.

Lap-Band

As of December 31, 2018, we had 101 total U.S. and foreign patents and patent applications related to our Lap-Band System. The international patents and patent applications are in regions including the United States, Germany, France, Spain, the UK, Mexico, Canada, Italy, the Netherlands, Portugal, Ireland, Belgium, Poland, Australia, and South Korea. The issued patents expire between the years 2020 and 2031. 

We also have 226 total U.S. and international trademarks for the LAP-BAND brand name.

ReShape Vest

As of December 31, 2018, we had four granted U.S. patents and four granted foreign patents in China, Israel, Canada and Australia related to our ReShape Vest. The patents expire between the years 2029 and 2032.

We also have U.S. and international trademark applications for the RESHAPE VEST brand name.

Sales and Distribution

We market directly to patients but sell the Lap-Band System to select surgical centers throughout the United States and internationally that have patients that would like to treat obesity and its comorbidities. The surgical centers then sell our product to the patients and implant. Our sales representatives are supported by field clinical experts who are responsible for training, technical support, and other support services at various implant centers. Our sales representatives implement consumer marketing programs and provide surgical centers and implanting surgeons with educational patient materials.

In connection with our acquisition of the Lap-Band System in December 2018, we entered into a transition services agreement, supply agreement and distribution agreement with Apollo pursuant to which, among other things, Apollo will manufacture the Lap-Band product for us for up two years and Apollo will serve as our distributor of the Lap-Band product outside of the United States for up to one year.

In order to support our Lap-Band sales efforts, we have increased the size of our dedicated U.S. sales team from two to six. We have also launched co-op marketing campaigns that allow us to partner with clinics in marketing efforts and use digital marketing to drive qualified leads to physicians. During the first half of 2019, our international sales efforts will be through a combination of distributor and direct sales channels, with a focus on top Lap-Band customers in Australia and Europe.

On July 25, 2017, we entered into a Collaboration Agreement with Galvani Bioelectronics Limited (“Galvani”). Under the Collaboration Agreement, we agreed to modify our ReShape vBloc for use in pre-clinical research by Galvani

Our Intellectual Property

Our success will depend in part on our ability to obtain and defend patent protectionexchange for payment for our productsdevelopment work and processes, to preserve our trade secretssupply under this agreement. We retained all rights, title, and to operate without infringingownership in the intellectual property for the new device. Galvani was granted a right of first negotiation for the potential exclusive or violatingnon-exclusive supply by us of the proprietary rights of third parties.developed device, exercisable at Galvani’s election. We own numerous U.S. and foreign patents, and have numerous patent applications pending, most of which pertain to treating gastrointestinal disordersnot collaborated with Galvani since late in 2017 and we believe provide us with broad intellectual property protection covering electrically-induced vagal blocking and methods for treating obesity. Assuming timely payment of maintenance fees as they become due, many of these patents will expire in 2023. We have also received or applied for patents in Europe, Australia, China, India and Japan. These applications primarily pertain to our vagal blocking technology and its application to obesity as well as other gastrointestinal disorders.

We also register the trademarks and trade names through which we conduct our business. To date, in the United States we have registered trademarks for vBLOC®, ENTEROMEDICS® and MAESTRO®, each registered with the United States Patent and Trademark Office, and trademark applications for vBLOC POWER TO CHOOSE and vBLOC POWER TO CHOOSE AND DESIGN. In addition, some or all of the marks vBLOC, ENTEROMEDICS, MAESTRO, MAESTRO SYSTEM ORCHESTRATING OBESITY SOLUTIONS, vBLOC POWER TO CHOOSE and vBLOC POWER TO CHOOSE AND DESIGN are the subject of either a trademark registration or application for registration in Australia, Brazil, China, the European Community, India, Kuwait, Mexico, Saudi Arabia, Switzerland and the United Arab Emirates.

In addition to our patents, we rely on confidentiality and proprietary information agreements to protect our trade secrets and proprietary knowledge. These confidentiality and proprietary information agreements generally provide that all confidential information developed or made known to individuals by us during the course of their relationship with us is to be kept confidential and not disclosed to third parties, except in specific circumstances. The agreements also provide for ownership of inventions conceived during the course of such agreements. If our proprietary information is shared or our confidentiality agreements are breached, we maydo not have adequate remedies, or our trade secrets may otherwise become knownany further plans to or independently developed by competitors.

re-engage any further research activities with them at this time.

Our Manufacturers and Suppliers

We have designed and developed allare party to a supply agreement with Apollo pursuant to which, among other things, Apollo will manufacture the Lap-Band product for us for up two years after our acquisition of the elements of our vBloc System, except for the clinician programmer hardware,Lap-Band product, which uses a commercially available laptop computer. was completed in December 2018.

To date, all of the materials and components of the systemour products, as well as any related outside services, are procured from qualified suppliers and contract manufacturers in accordance with our proprietary specifications. We use third parties to manufacture our vBloc System to minimize our capital investment, help control costs and take advantage of the expertise these third parties have in the large-scale production of medical devices. We do not currently plan to manufacture our vBloc System ourselves. All of our key manufacturers and suppliers have experience working with commercial implantable device systems, are ISO certified and are regularly audited by us.various regulatory agencies including the FDA. Our key manufacturers and suppliers have a demonstrated record of compliance with international regulatory requirements.

Since we received FDA approval on January 14, 2015, and commenced commercialization of the vBloc System in the United States, we have increased our production volume slowly in connection with the  controlled commercial launch of the vBloc System in the United States. Given that we rely primarily on third-party manufacturers and suppliers for the production of our products, our ability to increase production going forward will depend upon the experience, certification levels and large scale production capabilities of our suppliers and manufacturers. Qualified suppliers and contract manufacturers have been and will continue to be selected to supply products on a commercial scale according to our proprietary specifications. We have modestly increased our inventory levels to support commercial forecasts as we expand our implanting centers and intend to continue to increase our inventory levels as we determine necessary. Our FDA approval process required us to name and obtain approval for the suppliers of key components of our vBlocthe Lap-Band System.

Many of our parts are custom designed and require custom tooling and, as a result, we may not be able to quickly qualify and establish additional or replacement suppliers for the components of our vBloc System.products. Any new approvals of vendors required by the FDA or other regulatory agencies in other international markets for our vBloc Systemproducts as a result of the need to qualify or obtain alternate vendors for any of our components would delay our ability to sell and market the vBloc Systemour products and could have a material adverse effect on our business.

Medical devices in the United States are classified into one of three classes, Class I, II or III, on the basis of the amount of risk and the controls deemed by the FDA to be necessary to reasonably ensure their safety and effectiveness. Class I, low risk, devices are subject to general controls (e.g., labeling and adherence to good manufacturing practices). Class II, intermediate risk, devices are subject to general controls and to special controls (e.g., performance standards, and premarket notification). Generally, Class III devices are those which must receive premarket approval by the FDA to ensure their safety and effectiveness (e.g., life-sustaining, life-supporting and implantable devices, or new devices which have not been found substantially equivalent to legally marketed devices), and require clinical testing to ensure safety and effectiveness and FDA approval prior to marketing and distribution. The FDA also has the authority to require clinical testing of Class II devices. In both the United States and certain international markets, there have been a number of legislative and regulatory initiatives and changes, such as the Modernization Act and the EU-Medical Device Regulations, which could and have altered the healthcare system in ways that could impact our ability to sell our medical devices profitably.

The FFDCA provides two basic review procedures for medical devices. Certain products may qualify for a submission authorized by Section 510(k) of the FFDCA, where the manufacturer submits to the FDA a premarket notification of the manufacturer’s intention to commence marketing the product. The manufacturer must, among other things, establish that the product to be marketed is substantially equivalent to another legally marketed product. Marketing may commence when the FDA issues a letter finding substantial equivalence. If a medical device does not qualify for the 510(k) procedure, the manufacturer must file a premarket approval (PMA)PMA application with the FDA. This procedure requires more extensive pre-filing clinical and preclinical testing than the 510(k) procedure and involves a significantly longer FDA review process.

A PMA is required to establish the safety and effectiveness of the device and a key component of a PMA submission is the pivotal clinical trial data, as discussed in more detail below. 

Premarket Approval

Our ReShape vBloc and our Lap-Band System is an implanted deviceare medical devices that required PMAPMAs from the FDA to market in the United States. The FDA approved ReShape vBloc in January of 2015 and the vBlocLap-Band System on January 14, 2015in 2001 with post-approval conditions intended to ensure the safety and effectiveness of the device.devices. Failure to comply with the conditions of approval can result in material adverse enforcement action, including the loss or withdrawal of the approval.approvals. Even after approval of the PMA,PMAs, new PMAs or supplemental PMAs will be required for significant modifications to the manufacturing process, labeling, use and design of a device that is approved through the premarket approval process. Premarket approval supplements often require submission of the same type of information as a PMA except that the supplement is limited to information needed to support any

Pervasive and Continuing U.S. Regulation

Numerous regulatory requirements apply. These include:

Advertising and promotion of medical devices are also regulated by the Federal Trade Commission and by state regulatory and enforcement authorities. Recently, some promotional activities for FDA-regulated products have resulted in enforcement actions brought under healthcare reimbursement laws and consumer protection statutes. In addition, under the federal Lanham Act, competitors and others can initiate litigation relating to advertising claims.

Compliance with regulatory requirements is enforced through periodic facility inspections by the FDA, which may be unannounced. Because we rely on contract manufacturing sites and service providers, these additional sites are also subject to these FDA inspections. Failure to comply with applicable regulatory requirements can result in enforcement action, which may include any of the following sanctions:

2007/47/EC for active implantable medical devices and numerous standards that govern and harmonize the national laws and standards regulating the design, manufacture, clinical trials, labeling and adverse event reporting for medical devices that are marketed in member states. Medical devices that comply with the requirements of the national law of the member state in which their Notified Body is located will be entitled to bear CE marking, indicating that the device conforms to applicable regulatory requirements, and, accordingly, can be commercially marketed within the EEA and other countries that recognize this mark for regulatory purposes.

We obtained European CE Mark approval for our vBloc System in 2011 for the treatment of obesity. The CE Mark approval for our vBlocLap-Band System was expandedCE marked in 2014 to also include use for the management of Type 2 diabetes in obese patients.1997. The method of assessing conformity with applicable regulatory requirements varies depending on the class of the device, but for our vBlocLap-Band System, (which is considered an Active Implantable Medical Device (AIMD) in Australia and the EEA, and falls into Class III within the United States), the method involved a combination of self-assessment and issuance of declaration of conformity by the manufacturer of the safety and performance of the device, and a third-party assessment by a Notified Body of the design of the device and of our quality system. A Notified Body is a private commercial entity that is designated by the national government of a member state as being competent to make independent judgments about whether a product complies with applicable regulatory requirements. The assessment included, among other things, a clinical evaluation of the conformity of the device with applicable regulatory requirements. We use DEKRA Certification B.V. (formerly known as KEMA Quality) in the NetherlandsBSI as the Notified Body for our CE marking approval process.

Continued compliance with CE marking requirements is enforced through periodic facility inspections by the Notified Body, which may be unannounced. Because we rely on contract manufacturing sites and service providers, these additional sites may also be subject to these Notified Body inspections.

Patient Privacy Laws

United States and various international laws have been evolving to protect the confidentiality of certain patient health information, including patient medical records. These laws restrict the use and disclosure of certain patient health information. Enforcement actions, including financial penalties, related to patient privacy issues are globally increasing. The management of patient data may have an impact on certain clinical research activities and product design considerations.

Employees

As of December 31, 2016,2018, we had a total of 3243 employees. All of these employees are located in the United States.

From time to time we also employ independent contractors, consultants and temporary employees to support our operations. None of our employees are subject to collective bargaining agreements. We have never experienced a work stoppage and believe that our relations with our employees are good.

orthopedic medical devices. Mr. Youngstrom has previously served as Chief Financial Officer and Vice President, Finance with Anulex Technologies, Enpath Medical, Compex Technologies, Acist Medical Systems, and Cardiotronics.

Naqeeb (Nick) A. Ansari has served as our Senior Vice President of Sales since January 6, 2016. Mr. Ansari has over 20 years of experience in the medical device industry, having held various senior sales positions at Stryker Corporation, DePuy, Medtronic, Inc., Lanx, Inc. and Globus Medical Inc. Prior to joining the Company he spent two years as the owner of an independent distributor solely selling Biomet products. Prior to this, he served as Senior Vice President of Sales at Lanx, Inc. from 2010 to 2013.

Peter M. DeLange has served as our Senior Vice President of Operations and Business Development since January 18, 2016. Mr. DeLange has spent the last 11 years as the owner and President of Devicix, LLC a medical device engineering development company that was sold in 2015. At Devicix, he contracted with large medical device companies and worked closely with individual surgeons to develop new technologies. Since 2011, Mr. DeLange has also served as a Co-Founder and Board Member of FocusStart LLC, an early stage technology development company utilizing a capital efficient business model to advance medical technology. Prior to Devicix, he held software engineer and product development positions at numerous companies including ACIST Medical Systems, Nellcor Puritan Bennett, Emerson EMC and Quester Technology.

Paul F. Hickey has served as our Senior Vice President of Marketing and Reimbursement since January 18, 2016. Mr. Hickey has over 15 years of experience as a medical device executive, most recently having served as Chief Executive Officer of Pantheon Spinal, a small spine implant start-up company based in Austin, Texas, since 2014. Prior to Pantheon, he spent three years as Senior Vice President, Global Commercialization at Lanx, Inc., which was acquired by Biomet Spine in 2013, where he oversaw marketing, clinical reimbursement and R&D. Mr. Hickey also spent 17

We have invested, and expect to continue to invest, significant cash and other resources in connection with our acquisition of the Lap-Band product line, including our obligation to pay the remaining $7 million of the purchase price. Our efforts to successfully integrate and continue the commercialization of the Lap-Band product line will require significant cash expenditures. There can be no assurance that we will be successful in our efforts. Should we be unable to obtain adequate financing or generate sufficient revenue in the future, our business, results of operations, liquidity and financial condition could be materially and adversely harmed.

We face a risk of default under our security agreement with Apollo that we entered into in connection with our acquisition of the Lap-Band product line and under our subordinated secured debentures that we issued in March 2019.

In connection with our acquisition of the Lap-Band product line, we entered into a security agreement with Apollo pursuant to which we granted to Apollo a security interest in substantially all of our assets as security for our obligations under the asset purchase agreement entered into in connection with the transaction, including our obligation to pay the cash purchase price. The security interest will be terminated upon the earlier of the date we pay the cash purchase price to Apollo in full or complete an equity financing raising gross proceeds of at least $15 million. In March 2019, we issued $2.2 million in aggregate principal amount subordinated secured debentures and a related security agreement to secure our payment obligations under the debentures, which obligations and security interest are subordinated to our obligations to and security interest of Apollo. If we default on our payment obligations, Apollo and our other secured lenders have the right to enforce their rights under the security agreements, including by enforcing their security interest and taking control of substantially all of our assets and declaring the entire remaining portion of our outstanding obligations to be immediately due and payable. In addition, the security agreements contain certain restrictions that may adversely affect our ability to engage in certain business activities or finance our future operations or capital needs. Transactions that we may view as important opportunities, such as acquisitions, may be subject to the consent of Apollo or our other secured lenders, which consent may be withheld or granted subject to conditions specified at the time that may affect the attractiveness or viability of the transaction.

If we do not achieve the contemplated benefits of our acquisition of the Lap-Band product line, our business and financial condition may be materially impaired.

We may not achieve the desired benefits from our acquisition of the Lap-Band product line. For any of the reasons described above and elsewhere in this report and even if we are able to successfully integrate the Lap-Band product line within our company, we may not be able to realize the revenue and other growth that we anticipate from the acquisition in the time frame that we currently expect, and the costs of achieving these benefits may be higher than what we currently expect, because of a number of risks, including, but not limited to:

As a result of these risks, we may not achieve the anticipated strategic and financial benefits of the Lap-Band acquisition.

If we are unable to either substantially improve our operating results or obtain additional financing in the future, we will be unable to continue as a going concern.

Our independent registered public accounting firm’s report on our December 31, 2018 audited financial statements includes an explanatory paragraph referring to our ability to continue as a going concern. The proceeds from any future financings that we may be able to obtain, if any, together with our other available cash, may not be sufficient to fund our operating expenses, capital expenditures and other cash requirements. Should we be unable to obtain adequate financing or generate sufficient revenue in the future, our business, result of operations, liquidity and financial condition would be materially and adversely harmed, and we would be unable to continue as a going concern. These events and circumstances could have a material adverse effect on our ability to raise additional capital and on the market value of our common stock and the warrants offered hereby. Moreover, should we experience a cash shortage that requires us to curtail or cease our operations, or should we be unable to continue as a going concern, you could lose all or part of your investments in our securities.

We currently are not generating revenue from operations that is significant relative to our level of operating expenses, and we do not anticipate generating revenue sufficient to offset operating costs in the short-term to mid-term. We have financed our operations to date principally through the sale of equity securities. Our history of operating losses, limited cash resources and lack of certainty regarding obtaining significant third-party reimbursement for our products or timing thereof, raise substantial doubt about our ability to continue as a going concern. As of December 31, 2018, we had $5.5 million of cash and cash equivalents.  We expect our current cash and cash equivalents to fund our operations through early 2019.

Our anticipated operations include plans to (i) integrate the sales and operations of the Lap-Band product line as well as to obtain cost savings synergies (ii) continue development of the ReShape Vest, (iii) seek opportunities to leverage our intellectual property portfolio and custom development services to provide third party sales and licensing opportunities, and (iv) explore and capitalize on synergistic opportunities to expand our portfolio and offer future minimally invasive treatments and therapies in the obesity continuum of care. We believe that we have the flexibility to manage the growth of our expenditures and operations depending on the amount of available cash flows, which could include reducing expenditures for marketing, clinical and product development activities. However, we will ultimately need to achieve sufficient revenues from product sales and obtain additional debt or equity financing in addition to the proceeds from this offering to support our operations.

Our ReShape Vest product is in the early stages of clinical evaluation. If the clinical trial is not successfully completed or any required regulatory approvals are not obtained, the ReShape Vest may not be commercialized and our business prospects may suffer.

Our ReShape Vest product is in the early stages of development and is currently in the early stages of clinical evaluation. Our ability to market the ReShape Vest in the United States and abroad depends upon our ability to demonstrate the safety and effectiveness of the product with clinical data to support our requests for regulatory approval. The ReShape Vest may not be found to be safe and, where required, effective in clinical trials and may not ultimately be approved for marketing by U.S. or foreign regulatory authorities, which would have a negative impact on our net sales.

There is no assurance that we will be successful in achieving the desired results in our anticipated clinical trials for the ReShape Vest or, if we do, that the FDA or other regulatory agencies will approve the product for sale without the need for additional clinical trial data to demonstrate safety and efficacy. We continually evaluate the potential financial benefits and costs of clinical trials and the products being evaluated in them. If we determine that the costs associated with obtaining regulatory approval of a product exceed the potential financial benefits of that product or if the projected development timeline is inconsistent with our investment horizon, we may choose to stop a clinical trial and/or the development of a product.

The shares of series C convertible preferred stock issued in connection with our acquisition of ReShape Medical have certain rights and preferences senior to our common stock, including a liquidation preference that is senior to our common stock.

There are currently 95,388 shares of our series C convertible preferred stock outstanding, which are convertible into 4,543 shares of our common stock. We issued the shares of our series C convertible preferred stock in connection with our acquisition of ReShape Medical. The series C convertible preferred stock has a liquidation preference of

$274.8774 per share, or $5,772.4254 per underlying share of common stock, or approximately $26.2 million in the aggregate. Holders of the series C convertible preferred stock have the right to convert their shares into shares of common stock instead of receiving the liquidation preference. In general, the series C convertible preferred stock is entitled to receive dividends (on an as-if-converted-to-common stock basis) actually paid on shares of common stock when, as and if such dividends are paid on shares of common stock. No other dividends will be paid on shares of series C convertible preferred stock. While the series C convertible preferred stock generally does not have voting rights, as long as any shares of series C convertible preferred stock remain outstanding, we cannot, without the affirmative vote of holders of a majority of the then-outstanding shares of series C convertible preferred stock, (a) alter or change adversely the powers, preferences or rights given to the series C convertible preferred stock (including by the designation, authorization, or issuance of any shares of preferred stock that purports to have equal rights with, or be senior in rights or preferences to, the series C convertible preferred stock), (b) alter or amend the series C convertible preferred stock certificate of designation, (c) amend our certificate of incorporation or other charter documents in any manner that adversely affects any rights of the holders of series C convertible preferred stock, (d) increase the number of authorized shares of series C convertible preferred stock or (e) enter into any agreement with respect to any of the foregoing.

We are a medical device company with a limited history of operations no significant history ofand sales, in the United States and a limited history of sales in countries outside of the United States, and we cannot assure you that we will ever generate substantial revenue or be profitable.

We are a medical device company with a limited operating history upon which you can evaluate our business.  We received FDA approval to sell our product in the United States on January 14, 2015 and we have had commercial sales within the United States in 2015 and 2016. We have also completed the regulatory process required to sell our product in Australia, the European Economic Area and other countries that recognize the European CE Mark, and have not generated revenue from commercial sales outside of the United States since 2012 and then only on a limited basis in Australia and the Middle East. We have been engaged in research and development and clinical trials since our inception in 2002 and have invested substantially all of our time and resources in developing our vBloc Therapy, which we have begun to commercialize in the form of our vBloc System.products and product candidates. The success of our business will depend on our ability to establish a sales force, make sales and control costs, as well as our ability to obtain additional regulatory approvals needed to market new versions of our vBloc SystemLap-Band system or regulatory approvals needed to market our ReShape Vest and any other products we may develop in the future, all of which we may be unable to do. If we are unable to successfully market our vBloc SystemLap-Band system for its indicated use or develop and commercialize the ReShape Vest, we may never become profitable and may have to cease operations as a result. Our lack of a significant operating history also limits your ability to make a comparative evaluation of us, our products and our prospects.

We have incurred losses since inception and we anticipate that we will continue to incur losses for the foreseeable future.future.  

We have incurred losses in each year since our formation in 2002. Our net loss applicable to common stockholders forFor the fiscal years ended December 31, 2016, 20152018 and 20142017, our loss from continuing operations was $23.4 million, $25.5$35.3 million and $26.1$30.5 million, respectively, and our net loss attributable to common stockholders was $84.2 million and $33.8 million, respectively. We have funded our operations to date principally from the sale of securities and the issuance of indebtedness. Development of a new medical device, including conducting clinical trials and seeking regulatory approvals, is a long, expensive and uncertain process. Although we recently received the regulatory approval required to sell our vBloc System in the United States and have the approvals required for sales in the European Economic Area and

impairment loss related to our remaining indefinite-lived and finite-lived intangible assets, which could also have a material adverse effect on our results of operations.

We will need substantial additional funding and may be unable to raise capital when needed, which would force us to delay, reduce or eliminate our product development programs or liquidate some or all of our assets.

Our operations have consumed substantial amounts of cash since inception. We expect to continue to spend substantial amounts on the development and commercialization of our productproducts and on research and development, including conducting current and future clinical trials for our vBloc SystemLap-Band system, ReShape Vest (if approved for sale) and subsequent versions of our product. Cash used in operations was $20.6 million, $22.6 million and $19.4 million forproducts. For the fiscal years ended December 31, 2016, 20152018 and 2014,2017, net cash used in operating activities from continuing operations was $20.1 million and $22.1 million, respectively, and net cash used in operating activities (including discontinued operations) was $27.5 million and $24.6 million, respectively. We expect that our cash used in operations will continue to be significant in the upcoming years, and that we will need to raise additional capital to commercialize our vBloc System inLap-Band system, to develop the United States, the European Economic Area, other countries that recognize the European CE Mark and other international markets, to explore other indications for our product,ReShape Vest, to continue our research and development programs, and to fund our ongoing operations.

Our future funding requirements will depend on many factors, including:

Until the time, if ever, when we can generate a sufficient amount of product revenue, we expect to finance our future cash needs through public or private equity offerings, debt financings or corporate collaboration, licensing arrangements and grants, as well as through interest income earned on cash balances.

We may be subject to fines, restrictions or prohibitions on sales, or other penalties for failure to maintain licenses in certain states.

Certain of our licenses in states in which we currently conduct our business are expired, and we may not maintain required licenses in every state in which we conduct business. As a result, we could be subject to fines, restrictions or prohibitions on its sales, or other penalties under applicable state laws, which could adversely affect our business and results of operations.

We incur significant costs as a result of operating as a public company, and our management is required to devote substantial time to compliance initiatives.

As a public company, we incur significant legal, accounting and other expenses. In addition, the Sarbanes-Oxley Act of 2002 (the Sarbanes-Oxley Act)“Sarbanes-Oxley Act”), as well as rules subsequently implemented by the SEC and NASDAQ have imposed various requirements on public companies, including establishment and maintenance of effective disclosure and financial controls and changes in corporate governance practices. Our management and other personnel devote a substantial amount of time to these compliance initiatives. Moreover, these rules and regulations result in increased legal and financial compliance costs and will make some activities more time-consuming and costly.

The Sarbanes-Oxley Act requires, among other things, that we maintain effective internal controls for financial reporting and disclosure. In particular, we are required to perform system and process evaluation and testing of our internal controls over financial reporting to allow management to report on the effectiveness of our internal controls over financial reporting, as required by Section 404 of the Sarbanes-Oxley Act. Our testing may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses. There have been material weaknesses identified in the past and we have identified a material weakness as of December 31, 2018 related to our ability to maintain adequate accounting resources with a sufficient understanding of accounting principles generally accepted in the United States of America (“GAAP”) to allow the Company to identify and properly account for new complex transactions. Specifically, we did not design and implement internal controls around research and development expenses paid to a  CRO. This material weakness resulted in our not identifying that certain research and development expenses paid to the CRO in connection with the clinical trial of the ReShape Vest are required to be capitalized under GAAP, and recognized into expense as the value of the capitalized asset is realized.  

We have incurred and continue to expect to incur significant expense and devote substantial management effort toward ensuring compliance with Section 404.404 and remediating material weaknesses in our internal controls over financial reporting. Moreover, if we do not comply with the requirements of Section 404, or if we identify additional deficiencies in our internal controls that are deemed to be material weaknesses, the market price of our stock could decline and we could be subject to sanctions or investigations by NASDAQ, the SEC or other regulatory authorities, which would entail expenditure of additional financial and management resources.

We face significant uncertainty in the industry due to government healthcare reform.  reform.

In the United States, there have been and continue to be a number of legislative initiatives to contain healthcare costs. The Patient Protection and Affordable Care Act, as amended, (the Affordable“Affordable Care Act)Act”) as well as any future healthcare reform legislation, may have a significant impact on our business. The impact of the Affordable Care Act on the health care industry is extensive and includes, among other things, the federal government assuming a larger role in the health care system, expanding healthcare coverage of United States citizens and mandating basic healthcare benefits. The Affordable Care Act contains many provisions designed to generate the revenues necessary to fund the coverage expansions and to reduce costs of Medicare and Medicaid, including imposing a 2.3% excise tax on domestic sales of many medical devices by manufacturers that began in 2013. Although a moratorium was placed on the medical device excise tax in 2016 and 2017,through 2019, if it is reinstated, it may adversely affectCongress does not pass legislation further extending or otherwise eliminating the excise tax, our sales and selling, general and administrative expenses may be adversely affected in the cost of goods sold.future.

medical devices. At this time, it is not clear whether the Affordable Care Act will be repealed in whole or in part, and, if it is repealed, whether it will be replaced in whole or in part by another plan.plan and what impact those changes will have on coverage and reimbursement for healthcare items and services covered by plans that were authorized by the Affordable Care Act. We expect that additional state and federal healthcare reform measures will be adopted in the future, any of which could limit the amounts that federal and state governments will pay for healthcare products and services, and also indirectly affect the amounts that private payers are willing to pay. In addition, any healthcare reforms enacted in the future may, like the Affordable Care Act, be phased in over a number of years but, if enacted, could reduce our revenue, increase our costs, or require us to revise the ways in which we conduct business or put us at risk for loss of business. In addition, our results of operations, financial position and cash flows could be materially adversely affected by changes under the Affordable Care Act and changes under any federal or state legislation adopted in the future.

We are subject, directly or indirectly, to United States federal and state healthcare fraud and abuse and false claims laws and regulations. Prosecutions under such laws have increased in recent years and we may become subject to such litigation. If we are unable to, or have not fully complied with such laws, we could face substantial penalties.

Our operations are directly, or indirectly through customers, subject to various state and federal fraud and abuse laws, including, without limitation, the federal Anti-Kickback Statute and federal False Claims Act. These laws may impact, among other things, our sales, marketing and education programs.

The federal Anti-Kickback Statute prohibits persons from knowingly and willfully soliciting, offering, receiving or providing remuneration, directly or indirectly, in exchange for or to induce either the referral of an individual, or the furnishing or arranging for a good or service, for which payment may be made under a federal healthcare program such as the Medicare and Medicaid programs. Several courts have interpreted the statute’s intent requirement to mean that if any one purpose of an arrangement involving remuneration is to induce referrals of federal healthcare covered business, the statute has been violated. The Anti-Kickback Statute is broad and, despite a series of narrow safe harbors, prohibits many arrangements and practices that are lawful in businesses outside of the healthcare industry. Penalties for violations of the federal Anti-Kickback Statute include criminal penalties and civil sanctions such as fines, imprisonment and possible exclusion from Medicare, Medicaid and other federal healthcare programs. Many states have also adopted laws similar to the federal Anti-Kickback Statute, some of which apply to the referral of patients for healthcare items or services reimbursed by any source, not only the Medicare and Medicaid programs.

The federal False Claims Act prohibits persons from knowingly filing, or causing to be filed, a false claim to, or the knowing use of false statements to obtain payment from the federal government. Suits filed under the False Claims Act, known as “qui tam” actions, can be brought by any individual on behalf of the government and such individuals, commonly known as “whistleblowers,” may share in any amounts paid by the entity to the government in fines or settlement. The frequency of filing qui tam actions has increased significantly in recent years, causing greater numbers of medical device, pharmaceutical and healthcare companies to have to defend a False Claim Act action. When an entity is determined to have violated the federal False Claims Act, it may be required to pay up to three times the actual damages sustained by the government, plus civil penalties for each separate false claim. Various states have also enacted laws modeled after the federal False Claims Act.

We are unable to predict whether we could be subject to actions under any of these laws, or the impact of such actions. If we are found to be in violation of any of the laws described above or other applicable state and federal fraud and abuse laws, we may be subject to penalties, including civil and criminal penalties, damages, fines, exclusion from government healthcare reimbursement programs and the curtailment or restructuring of our operations.

products than we do. Smaller or early-stage companies may also prove to be significant competitors, particularly if they pursue competing solutions through collaborative arrangements with large and established companies, such as Allergan, Apollo Endosurgery, Boston Scientific, LivaNova PLC, Johnson & Johnson, Medtronic or St. Jude Medical. Our competitors may develop and patent processes or products earlier than us, obtain regulatory approvals for competing products more rapidly than we are able to and develop more effective, safer and less expensive products or technologies that would render our products non-competitive or obsolete.

Failure to protect our information technology infrastructure against cyber-based attacks, network security breaches, service interruptions, or data corruption could significantly disrupt our operations and adversely affect our business and operating results.

We currently rely on information technology and telephone networks and systems, including the Internet, to process and transmit sensitive electronic information and will rely on such systems to manage or support a variety of business processes and activities, including sales, billing, customer service, procurement and supply chain, manufacturing, and distribution. We use enterprise information technology systems to record, process, and summarize financial information and results of operations for internal reporting purposes and to comply with regulatory financial reporting, legal, and tax requirements.

Our information technology systems, some of which are managed by third-parties, may be susceptible to damage, disruptions or shutdowns due to computer viruses, attacks by computer hackers, failures during the process of upgrading or replacing software, databases or components thereof, power outages, hardware failures, telecommunication failures, user errors or catastrophic events. We are not aware of any breaches of our information technology infrastructure. Despite the precautionary measures we have taken to prevent breakdowns in our information technology and telephone systems, if our systems suffer severe damage, disruption or shutdown and we are unable to effectively resolve the issues in a timely manner, our business and operating results may suffer.

Risks Associated with Development and Commercialization of the vBloc SystemLap-Band system and ReShape Vest

Our efforts to increase revenue from our Lap-Band system and commercialize our vBloc Systemthe ReShape Vest may not succeed or may encounter delays which could significantly harm our ability to generate revenue.

Our ability to generate revenue will depend upon the sales of our Lap-Band system and successful commercialization of our vBloc System.ReShape Vest (if approved for sale). Our efforts to commercialize this productthese products may not succeed for a number of reasons, including:

Besides requiring physician adoption, market acceptance of our vBloc Systemproducts will depend on successfully communicating the benefits of our vBloc Therapyproducts to three additional constituencies involved in deciding whether to treat a particular patient using such therapy:our products: (1) the potential patients themselves; (2) institutions such as hospitals, where the procedure would be performed and opinion leaders in these institutions; and (3) third-party payers, such as private healthcare insurers and governmental payers, such as Medicare and Medicaid in the United States, which would ultimately bear most of the costs of the various providers and equipment involved in our vBloc Therapy.Lap-Band system and ReShape Vest (if approved for sale). Marketing to each of these constituencies requires a different marketing approach, and we must convince each of these groups of the efficacy and utility of our vBloc Therapyproducts to be successful.

If our vBloc Therapy,products, or any other neuroblocking therapy or products for other gastrointestinal diseases and disorders that we may develop, doesdo not achieve an adequate level of acceptance by the relevant constituencies, we may not generate significant product revenue and may not become profitable.

After we received FDA approval on January 14, 2015, we began the commercialization processWe may not be able to obtain required regulatory approvals for our vBloc SystemReShape Vest in a cost-effective manner or at all, which could adversely affect our business and operating results.

The production and marketing of our ReShape Vest and our ongoing research and development, preclinical testing and clinical trial activities are subject to extensive regulation and review by numerous governmental authorities both in the United States and had our first commercial sales withinabroad. U.S. and foreign regulations applicable to medical devices are wide-ranging and govern, among other things, the United Statesdevelopment, testing, marketing and premarket review of new medical devices, in 2015. Previously, in 2012, we commenced commercial sales of our vBloc System in Australiaaddition to regulating manufacturing practices, reporting, advertising, exporting, labeling and the Middle East, but have not generated revenue from commercial sales outside of the United States since 2012 as we focused our resources on the U.S.record keeping procedures. We are required to obtain regulatory approval process and commercialization ofbefore we can market our productReShape Vest in the United States and we do not know when, or if, wecertain foreign countries. The regulatory process will have the resourcesrequire significant time, effort and expenditures to commercialize our vBloc System internationally. If we are not successful in the commercialization of our vBloc System for the treatment of obesity we may not generate enough revenue to offset our expenses and may be forced to cease operations as a result.

We have not received, and may never receive, approval from the regulatory bodies of any foreign country other than the European Economic Areabring products to market, our vBloc System for the treatment of obesity.

We do not have the necessary regulatory approvals to market our vBloc System in any foreign market other than the European Economic Area for which we received CE Mark approval for our vBloc System in March 2011 for the treatment of obesity and other countries which accept these regulatory approvals. Additionally, the vBloc System was previously listed on the Australian Register of Therapeutic Goods (ARTG). The CE Mark approval for our vBloc System was expanded in 2014 to also include use for the management of Type 2 diabetes in obese patients. We commenced commercialization of our product in Australia and the Middle East in 2012, but have not generated revenue from commercial sales outside of the United States since 2012 as we focused our resources on the U.S. regulatory

as expected, our trials could be delayed or terminated. If these clinical investigators, clinical sites or other third parties do not carry out their contractual duties or obligations or fail to meet expected deadlines, or if the quality or accuracy of the clinical data they obtain is compromised due to their failure to adhere to our clinical protocols, regulatory requirements or for other reasons, our clinical trials may be extended, delayed or terminated, or the clinical data may be rejected by the FDA, adversely affecting our ability to successfully commercialize our product.

Modifications to the vBloc SystemLap-Band system may require additional approval from regulatory authorities, which may not be obtained or may delay our commercialization efforts.

The FDA and our European Notified Body require medical device companies to initially make and document a determination of whether or not a modification requires a new approval, supplement or clearance; however, some of these regulatory authorities can review a company’s decision. Any modifications to an approved device that could significantly affect its safety or efficacy, or that would constitute a major change in its intended use could require additional clinical studies and separate regulatory applications. Product changes or revisions will require all the regulatory steps and associated risks discussed above possibly including testing, regulatory filings and clinical study. We may not be able to obtain approval of supplemental regulatory approvals for product modifications, new indications for

customers. There can be no assurance that there will not be product recalls in the future or that such recalls would not have a material adverse effect on our business. Once the product is approved and implanted in a large number of patients, infrequently occurring adverse events may appear that were not observed in the clinical trials. This could cause health authorities in countries where the product is available to take regulatory action, including marketing suspension and recall.

We may be unable to manage our growth effectively.

Our business strategy entails significant future growth. For example, we will have to expand existing operations in order to increase revenue from our Lap-Band system and develop our ReShape Vest, conduct additional clinical trials, increase our contract manufacturing capabilities, hire and train new personnel to handle the marketing and sales of our product, assist patients and healthcare providers in obtaining reimbursement for the use of our product and create and develop new applications for our technology. This growth may place significant strain on our management and financial and operational resources. Successful growth is also dependent upon our ability to implement appropriate financial and management controls, systems and procedures. Our ability to effectively manage growth depends on our success in attracting and retaining highly qualified personnel, for which the competition may be intense. If we fail to manage these challenges effectively, our business could be harmed. 

medical device companies, including ours, can be highly uncertain and involve complex and evolving legal and factual questions. We do not know whether we will obtain the patent protection we seek, or that the protection we do obtain will be found valid and enforceable if challenged. If we fail to obtain adequate protection of our intellectual property, or if any protection we obtain is reduced or eliminated, others could use our intellectual property without compensating us, resulting in harm to our business. We may also determine that it is in our best interests to voluntarily challenge a third-party’s products or patents in litigation or administrative proceedings, including patent interferences, re-examinations or under more recently promulgated Inter Partes Review proceedings, depending on when the patent application was filed. In the event that we seek to enforce any of our owned or exclusively licensed patents against an infringing party, it is likely that the party defending the claim will seek to invalidate the patents we assert, which, if successful could result in the loss of the entire patent or the relevant portion of our patent,

scientific advisors and third parties. These agreements may be breached, and we may not have adequate remedies for any such breach. In addition, our trade secrets may otherwise become known or be independently developed by competitors. To the extent that our employees, consultants or contractors use intellectual property owned by others in their work for us, disputes may arise as to the rights in related or resulting know-how and inventions.

Risks Relating to Ownership of Our Common Stock

Our common stock has been delisted from the Nasdaq Stock Market and our shares currently trade on an over-the-counter market.

On December 27, 2018, we received a written notice from the Office of General Counsel of The Nasdaq Stock Market notifying us that the Nasdaq Hearings Panel (the “Panel”) had determined to delist our securities pursuant to Nasdaq’s discretionary authority under Listing Rule 5101. The Panel also cited in its decision our failure to maintain compliance with the minimum bid price requirement under Listing Rule 5550(a)(2) and our failure to comply with Listing Rule 5250(e), which requires a company to file a Notification Form Listing of Additional Shares at least 15 days prior to the issuance or potential issuance of common stock greater than 10% of the total shares outstanding. As a result of the Panel’s decision, Nasdaq suspended trading in our common stock effective with the open of business on December 31, 2018 and our common stock has now been delisted from Nasdaq.

Our common stock currently trades on the OTCQB market and therefore may have less liquidity and may experience potentially more price volatility than experienced on Nasdaq. Stockholders may not be able to sell their shares of common stock on the OTCQB market in the quantities, at the times, or at the prices that could potentially be available on a more liquid trading market. The delisting of our common stock from Nasdaq could also adversely affect our ability to obtain financing for our operations and/or result in a loss of confidence by investors or employees.

Our common stock may be deemed to be a “penny stock” and broker-dealers who make a market in our stock may be subject to additional compliance requirements.

If our common stock is deemed to be a “penny stock” as defined in the Securities Exchange Act of 1934, broker-dealers who make a market in our stock will be subject to additional sales practice requirements for selling our common stock to persons other than established customers and accredited investors. For instance, the broker-dealer must make a special suitability determination for the purchaser and receive the purchaser's written agreement to the transaction prior to the sale. Consequently, the penny stock rules, if they were to become applicable, would affect the ability or willingness of broker-dealers to sell our securities, and accordingly would affect the ability of stockholders to sell their securities in the public market. These additional procedures could also limit our ability to raise additional capital in the future.

The trading price of our common stock has been volatile and is likely to be volatile in the future.

The trading price of our common stock has been highly volatile. Further, our common stock has a limited trading history. Since our public offering in November 2007 through February 28, 2017 our stock price has fluctuated from a low of $1.75 to a high of $67,851.00, as adjusted forvolatile and may be more volatile now that it trades on the 1-for-70 reverse split of our common stock that was effected

The stock prices of many companies in the medical device industry have experienced wide fluctuations that have often been unrelated to the operating performance of these companies. Following periods of volatility in the market price of a company’s securities, securities class action litigation often has been initiated against a company. If class action litigation is initiated against us, we may incur substantial costs and our management’s attention may be diverted from our operations, which could significantly harm our business.

convertible into or exercisable to purchase common stock, at a lower price per share, to such lower price. Of our outstanding warrants as of December 31, 2018, warrants exercisable to purchase 41,963 shares of common stock with an exercise price of $1.25 per share contained a full-ratchet anti-dilution provision, and shares of convertible preferred stock convertible into 127,200 shares of common stock at a conversion price of $1.25 per share contained a full-ratchet anti-dilution provision. These full ratchet anti-dilution provisions would be triggered by the future issuances by us of shares of our common stock or common stock equivalents at a price per share below the then-exercise price of the warrants and the then-conversion price of the convertible preferred stock, subject to limited exceptions. In the event of a liquidation, the holders of shares of series C convertible preferred stock are entitled to be paid, before any payments are to be made to the holders of common stock or any other series of preferred stock, an amount per share equal to the greater of (i) $5,772.4254 per share (on an as-converted-to-common stock basis), or an aggregate of approximately $26.2 million, plus any dividends declared but unpaid thereon, or (ii) such amount per share as would have been payable had all shares of series C convertible preferred stock been converted to common stock immediately prior to such liquidation. 

In addition to the dilutive effects described above, the perceived risk of dilution as a result of the significant number of outstanding warrants, options and shares of convertible preferred stock may cause our common stockholders to be more inclined to sell their shares, which would contribute to a downward movement in the price of our common stock. Moreover, the perceived risk of dilution and the resulting downward pressure on our common stock price could encourage investors to engage in short sales of our common stock, which could further contribute to price declines in our common stock. The fact that our stockholders, warrant holders and option holders can sell substantial amounts of our common stock in the public market, whether or not sales have occurred or are occurring, as well as the existence of full-ratchet anti-dilution provisions in a substantial number of our outstanding warrants and shares of convertible preferred stock, could make it more difficult for us to raise additional funds through the sale of equity or equity-related securities in the future at a time and price that we deem reasonable or appropriate, or at all.

You may experience future dilution as a result of future equity offerings.

In order to raise additional capital for general corporate purposes, in the future we may offer additional shares of our common stock or other securities convertible into or exchangeable for our common stock at prices that may be lower than the current price per share of our common stock. In addition, investors purchasing shares or other securities in the future could have rights superior to existing stockholders. The price per share at which we sell additional shares of our common stock, or securities convertible or exchangeable into common stock, in future transactions may be higher or lower than the price per share paid by investors in prior offerings.

Since our securities are currently quoted on the OTCQB market, our stockholders may face significant restrictions on the resale of our securities due to state “blue sky” laws.

Each state has its own securities laws, often called “blue sky” laws, which (i) limit sales of securities to a state’s residents unless the securities are registered in that state or qualify for an exemption from registration, and (ii) govern the reporting requirements for broker-dealers doing business directly or indirectly in the state. Before a security is sold in a state, there must be a registration in place to cover the transaction, or the transaction must be exempt from registration. The applicable broker must be registered in that state. We do not know whether our common stock will be registered or exempt from registration under the laws of any state. Since our common stock is currently quoted on the OTCQB, a determination regarding registration will be made by those broker-dealers, if any, who agree to serve as the market-makers for our common stock. There may be significant state blue sky law restrictions on the ability of investors to sell, and on purchasers to buy, our common stock. Investors should therefore consider the resale market for our common stock to be limited, as they may be unable to resell your common stock without the significant expense of state registration or qualification.

Our organizational documents and Delaware law make a takeover of our company more difficult, which may prevent certain changes in control and limit the market price of our common stock.

Our certificate of incorporation and bylaws and Section 203 of the Delaware General Corporation Law contain provisions that may have the effect of deterring or delaying attempts by our stockholders to remove or replace management, engage in proxy contests and effect changes in control. These provisions include:

increase in the number of shares authorized for grant under our Second Amended and Restated 2003 Stock Incentive Plan (the “Plan”), which was approved by our shareholders at the Special Meeting of Shareholders held on December 12, 2016 (the “Special Meeting”), and to our subsequent grant of stock options on February 8, 2017, to ourthe Company’s Directors and senior management to purchase an aggregate of 1,093,450521 shares of our common stock (the “Option Grants”). In the complaint, the plaintiff contendscontended that (i) the number of shares authorized for grant under the Plan, as adjusted by ourthe board of directors after the Special Meeting for the subsequent recapitalization of the Company, resulted from an alleged breach of fiduciary duties by the Board,board of directors, and (ii) our senior management was allegedly unjustly enriched by the subsequent Option Grants. The plaintiff seekssought relief in the form of an order rescinding the Plan as approved by the shareholders at the Special Meeting, an order cancelling the Option Grants, and an award to plaintiff for his costs, including fees and disbursements of attorneys, experts and accountants. The parties settled the matter on December 17, 2018. The terms of the settlement require us to (i) rescind and cancel the Option Grants, with the exception of options that were already rescinded when certain individuals left the company in the last fiscal quarter of 2017, (ii) amend the Plan to add a provision establishing the maximum total annual equity compensation for non-employee directors and to seek stockholder approval of this amendment at the Company’s next annual meeting of stockholders, and (iii) proportionally adjust all share reserves and limitations in the Plan (and any other equity compensation plan for the company) in connection with any future split of the company’s stock during the next five years unless otherwise brought to and approved by stockholder vote. The Company is required to pay $197,000 and this was fully accrued for in 2018.

Fulfillium. On April 20, 2017, Fulfillium, Inc. filed a complaint against ReShape Medical, Inc. (which the Company acquired in October 2017 and which is now a wholly owned subsidiary of the Company) in the U.S. District Court for the District of Delaware, which alleged misappropriation of trade secrets and infringement of two U.S. Patents (“Fulfillium I”). On July 28, 2017, ReShape Medical moved to dismiss both the trade secret claim and certain aspects of the patent infringement claim, and to transfer the litigation to the U.S. District Court for the Central District of California. On October 16, 2017, the Court granted ReShape Medical’s motion to dismiss the trade secret and willful infringement claims, and ordered the case transferred to the U.S. District Court for the Central District of California. Fulfillium twice amended its complaint, narrowing its original trade secret claim and adding further patent infringement claims and additional parties. On June 4, 2018, ReShape Medical filed a motion to dismiss the patent infringement claims for lack of standing, which the Court granted on July 5, 2018. On August 10, 2018, the Court dismissed without prejudice the trade secret claim for lack of subject matter jurisdiction and terminated the case. Fulfillium has appealed these dismissals and ReShape Medical has appealed the grant and denial of certain attorney fee awards. On July 20, 2018, Fulfillium filed a new complaint against ReShape Lifesciences, Inc. (and its wholly owned subsidiary ReShape Medical LLC) in the U.S. District Court for the Central District of California (“Fulfillium II”) reasserting the patent infringement claims asserted in Fulfillium I. On August 15, 2018, Fulfillium amended its complaint in Fulfillium II to reassert the trade secret misappropriation claim asserted in Fulfillium I against ReShape Medical LLC and others. On September 7, 2018, Fulfillium filed a complaint in California state court alleging the same trade secret misappropriation claim asserted in both Fulfillium I and Fulfillium II. On November 7, 2018, the Court dismissed the non-Company parties from Fulfillium II. On April 20, 2018, ReShape Medical filed Inter Partes Review (“IPR”) petitions with the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office (the “PTAB”) to have all claims of both of the originally asserted Fulfillium patents canceled as unpatentable over various combinations of prior art. On November 6, 2018, the PTAB denied those petitions. The parties held a mediation on April 9, 2019, but were unable to resolve the matter. The Company intends to continue to vigorously defend itself against Fulfillium’s claims. We currently are unable to estimate the losses or range of losses for these two matters where there is a reasonable possibility of a loss or it is probable that a loss may have been incurred.

On July 12, 2018, Alpha Capital Anstalt (“Alpha”) filed a complaint against the Company in the U.S. District Court for the Southern District of New York. In August 2017, Alpha acquired shares of the Company’s series B convertible preferred stock and warrants to purchase shares of the Company’s common stock in an underwritten public offering. Pursuant to the terms of the series B convertible preferred stock and warrants, the conversion price of the series B convertible preferred stock and exercise price of the warrants was subject to adjustment in the case of, among other things, dilutive issuances of securities by the Company. The complaint alleges breach of contract, claiming that the Company should have adjusted the conversion price of the series B convertible preferred stock and exercise price of the warrants to not less than $420.00 per share, rather than the $1,575.00 per share to which the Company actually adjusted such conversion price and exercise price, in connection with its registered direct offering of series D convertible preferred stock and warrants to purchase common stock that it completed and announced in April 2018. Alpha seeks declaratory relief, damages of not less than approximately $3.6 million (less the proceeds of actual sales of the Company’s common stock made by Alpha) and attorneys’ fees. The Company believes the claims alleged are without merit and intends to vigorously protect and defend itself. However, we are currently unable to estimate a loss or range of loss for this matter.

attorneys, experts

On July 26, 2018, Iroquois Capital Investment Group, LLC and accountants.  We believeIroquois Master Fund, Ltd. filed a complaint against the allegationsCompany in the U.S. District Court for the Southern District of New York, with substantially the same claims and seeking substantially the same relief as Alpha’s complaint described above, except that Iroquois claims that the conversion price of the series D convertible preferred stock and exercise price of the warrants should have been adjusted to $189.00 per share, and Iroquois is claiming damages estimated to exceed $5 million. The Company believes the claims alleged are without merit and intendintends to vigorously protect and defend the action vigorously. itself. However, we are currently unable to estimate a loss or range of loss for this matter

Except as disclosed in the foregoing paragraph, we areparagraphs, the Company is not currently a party to any litigation and we arethe Company is not aware of any pending or threatened litigation against usit that could have a material adverse effect on ourthe Company’s business, operating results or financial condition. The medical device industry in which we operatethe Company operates is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. As a result, wethe Company may be involved in various legal proceedings from time to time.

ITEM 4. MINE SAFETY DISCLOSURES

Not applicable.

PART II. 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Forfor Our Common Stock

Our common stock has beenis traded on the NASDAQ StockOTCQB Market under the symbol “ETRM” since our initial public offering (IPO) on November 15, 2007. Prior to that date, there was no public market for our common stock. Our stock was traded on the NASDAQ Global Market from its initial listing at the time of our IPO until January 21, 2010. Subsequently, in anticipation of not curing our deficiencies with the continued listing requirements of the NASDAQ Global Market, we requested and were approved to transfer to the NASDAQ Capital Market, effective January 22, 2010.

RSLS. As of February 28, 2017,March 31, 2019, there were approximately 3719 holders of record of our common stock and 6,873,878  shares of common stock outstanding. No dividends have been paid on our common stock to date, and we do not anticipate paying any dividends in the foreseeable future.stock.

The following table sets forth the high and low sales prices of our common stock as quoted on the NASDAQ Stock Market and OTC Markets for the periods indicated. These prices have been adjusted to reflect the 1-for-70 reverse split of our common stock that was effected after trading on December 27, 2016 and the 1-for-15 reverse split of our common stock that was effected after trading on January 6, 2016.

Price Range of Common Stock

ITEM 7.  MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Except for the historical information contained herein, the matters discussed in this “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and elsewhere in this Form 10-K are forward-looking statements that involve risks and uncertainties. The factors listed in Item 1A “Risk Factors,” as well as any cautionary language in this Form 10-K, provide examples of risks, uncertainties and events that may cause our actual results to differ materially from those projected. Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.

Overview

We are a developer of minimally invasive medical device company with approvals to commercially launch our product, the vBloc Neuromodulation System (vBloc System), in the United States,  the European Economic Area and other countries that recognize the European CE Mark. We are focused on the design and development of devices that use neuroblocking technologyadvance bariatric surgery to treat obesity and metabolic diseasesdiseases. Our current portfolio includes the LAP-BAND® Adjustable Gastric Banding System and other gastrointestinal disorders. Our proprietary neuroblocking technology, whichthe ReShape VestTM, an investigational device, to help treat more patients with obesity. 

In December 2018, we refer to as vBloc Therapy, is designed to intermittently block the vagus nerve using high frequency, low energy, electrical impulses. We have a limited operating history and only recently received U.S. Food and Drug Administration (FDA) approval to sell our product in the United States. In addition, we have regulatory approval to sell our product in the European Economic Area and other countries that recognize the European CE Mark and currently do not have any other source of revenue. We were incorporated in Minnesota on December 19, 2002 and later reincorporated in Delaware on July 22, 2004. We have devotedacquired from Apollo Endosurgery, Inc. (“Apollo”) substantially all of our resourcesthe assets exclusively related to Apollo’s Lap-Band product line and Apollo acquired from us substantially all of the assets exclusively related to the our ReShape Balloon product line (“Asset Purchase Agreement”).  The assets and operating results of the ReShape Balloon product line prior to disposal have been reflected as discontinued operations in the Consolidated Financial Statements. As a result of our acquisition of the Lap-Band product line, we will no longer be actively marketing our ReShape vBloc product.

Financial Overview

Results of Operations – Continuing Operations

Revenue. Revenue from continuing operations totaled $0.6 million in both of the years ended December 31, 2018 and 2017. In 2018, revenue included sales of our recently acquired Lap-Band product of $0.4 million and sales of our ReShape vBloc product of $0.2 million. In 2017, revenue was comprised of $.3 million in sales of our ReShape vBloc product and $0.3 million in other revenue related to custom development services based on our intellectual property portfolio that had been requested and contracted for by a third party.

Cost of revenue. Cost of revenue from continuing operations was $0.2 million for the year ended December 31, 2018 compared to $0.3 million for the year ended December 31, 2017. For 2018, cost of revenue was comprised of $0.1 million related to Lap-Band product sales, and $0.1 million related to sales of our ReShape vBloc product. In 2017, cost of revenue was comprised of $0.2 million related to sales of our ReShape vBloc product and $0.1 million related to cost of services in connection with the custom development.

Selling, General and Administrative Expenses. Selling, general and administrative expenses from continuing operations were $19.3 million for the year ended December 31, 2018, compared to $22.8 million for the year ended December 31, 2017. The reduction was primarily due to reduced headcount in 2018 in connection with a strategic realignment of our operations.

Research and Development Expenses. Research and development expenses from continuing operations were $5.7 million for the year ended December 31, 2018 compared with $5.4 million for the year ended December 31, 2017. The increase was primarily attributable to a full year of research and development activities associated with of our ReShape Vest, acquired with our acquisition of BarioSurg in May 2018. Our ReShape Vest product is in the early stages of development and commercializationis currently in an initial clinical trial stage.

Goodwill Impairment. The goodwill impairment of $14.0 million for the year ended December 31, 2018 reflects the full write-down of the vBloc System,goodwill recorded in connection with our acquisition of BarioSurg, Inc. As discussed further in Note 8 to the Consolidated Financial Statements, we performed an impairment analysis due to the significant decline in our stock price following our registered direct securities offering in April 2018, which was formerly known as the Maestro Rechargeable System.

The vBloc System uses vBloc Therapy to limit the expansion of the stomach, help control hunger sensations between meals, reduce the frequency and intensity of stomach contractions and produce a feeling of early and prolonged fullness. We believe the vBloc System offers obese patients a minimally-invasive treatment that can result in significant, durable and sustained weight loss. We believe that our vBloc System allows bariatric surgeons to offer a new option to obese patients who are concerned about the risks and complications associated with currently available anatomy-altering, restrictive or malabsorptive surgical procedures.

We received FDA approval on January 14, 2015 for vBloc Therapy, delivered via the vBloc System, for the treatment of adult patients with obesity who have a Body Mass Index (BMI) of at least 40 to 45 kg/m2, or a BMI of at least 35 to 39.9 kg/m2 with a related health condition such as high blood pressure or high cholesterol levels, and who have tried to lose weight in a supervised weight management program and failed within the past five years. In 2015 we began a controlled commercial launch at select surgical centersresulted in the United States and had our first commercial sales. During 2015, we initiated a controlled expansionimpairment of our commercial operations and started the process of building a sales force. In January 2016, we hired new executives to oversee this expansion. Our direct sales force is supported by field clinical engineers who provide training, technical and other support services to our customers. Throughout 2016, our sales force called directly on key opinion leaders and bariatric surgeons at commercially-driven surgical centers that met our certification criteria.  Additionally, in 2016, through a distribution agreement with Academy Medical, LLC, U.S. Department of Veterans Affairs (VA) medical facilities now offer the vBloc System as a treatment option to veterans using their veteran healthcare benefits. We plan to build on these efforts in 2017 with self-pay and veteran patient focused direct-to-patient marketing, key opinion leader and center specific partnering, and a multi-faceted reimbursement strategy. To date, we have relied on, and anticipate that we will continue to rely on, third-party manufacturers and suppliers for the production of the vBloc System.goodwill.  

Recharge Trial

Data from our ReCharge trial was used to support the premarket approval (PMA) application for the vBloc System, submitted to the FDA in June 2013. The ReCharge trial is a randomized, double-blind, sham-controlled, multicenter pivotal clinical trial testing the effectiveness and safety of vBloc Therapy utilizing our vBloc System. All patients in the trial received an implanted device and were randomized in a 2:1 allocation to treatment or sham control groups. The sham control group received a non-functional device during the trial period. All patients were expected to participate in a standard weight management counseling program. The primary endpoints of efficacy and safety were

evaluated at 12 months. As announced,

Warrants Expense. Warrant expense of $0.1 million for the ReCharge trial met its primary safety endpointyear ended December 31, 2018 is primarily related to the change in fair value of certain warrants held by an institutional investor for which the exercise price was reduced as an inducement for the investor to exercise the warrants. For the year ended December 31, 2017 in connection with a 3.7% serious adverse event rate. The safety profile at 12 monthsour public offering of series B convertible preferred stock in August 2017, we recorded $4.4 million for the value of warrants issued to former investors as consideration for the waiver by each investor of their right to participate in future securities offerings by the Company.

Net Interest Expense. Interest expense was further supported by positive cardiovascular signals including$12,000 for the year ended December 31, 2018 compared with $3,000 for the year ended December 31, 2017. In 2018, we recorded $14,000 of accretion of interest expense on the net present value of the a 5.5 mmHg dropsset purchase consideration payable for our acquisition of the Lap-Band product line. Interest expense in systolic blood pressure, a 2.8 mmHg dropboth 2018 and 2017 was recorded net of an insignificant amount of interest income. We do not hold any investment securities in diastolic blood pressure and a 3.6 bpm drop in average heart rate.2018 or 2017.

Additionally,Income tax benefit.  Income tax benefit from continuing operation was $3.4 million and $2.3 million for the trial demonstrated in the intent to treat (ITT) population (n=239) a clinically meaningfulyears ended December 31, 2018 and statistically significant excess weight loss (EWL) of 24.4% (approximately 10% total body weight loss (TBL)) for vBloc Therapy-treated patients, with 52.5% of patients achieving at least 20% EWL, although it did not meet its co-primary efficacy endpoints. In the per protocol population, the trial demonstrated an EWL of 26.3% for vBloc Therapy-treated patients, with 56.8% of patients achieving at least 20% EWL.  We subsequently announced that vBloc Therapy-treated patients were maintaining their weight loss at 18 months and 24 months with an EWL of 23.5% and 21.1%,2017, respectively. The trial’s positive safety profile also continued throughout this reported timetax benefit recorded in 2018 is attributable to the losses for U.S. federal income tax purposes, which, effective with the enactment of the 2017 Tax Cuts and Jobs Act, have an unlimited carryforward period. For more information onThe tax benefit in 2017 was primarily the result of the revaluation of our Recharge Trialdeferred income taxes upon enactment of the 2017 Tax Cuts and Jobs Act.

Results of Operations – Discontinued Operations

Results of operations from discontinued operations reflect the activities of our other ongoing clinical trials, please see Item 1, Business, “Our Clinical Experience,” Reshape Balloon product line, which we acquired as part of our acquisition of ReShape Medical, Inc. in this Annual Report on Form 10-KOctober 2017 and sold in December 2018 in connection with our acquisition of the Lap-Band product line assets. Loss from discontinued operations was $45.9 million and $3.4 million for the Year Endedyears ended December 31, 2016.

We obtained European CE Mark approval for our vBloc System2018 and 2017, respectively. The loss in 20112018 includes an impairment charge of $13.2 million for the treatmentfull write-down of obesity. The CE Mark approval forthe goodwill recorded in connection with our vBloc Systemacquisition of ReShape Medical.  In addition, in connection with the determination of the fair value of the Lap-Band assets acquired, no value was expanded in 2014assigned to also include usethe ReShape Balloon product line assets sold as projections updated during the fourth quarter of 2018 indicated negative cash flows. Accordingly, the loss from discontinued operations for the managementyear ended December 31, 2018 includes an impairment charge of Type 2 diabetes in obese patients. In January 2012, the final vBloc System components were listed on the Australian Register of Therapeutic Goods (ARTG) by the Therapeutic Goods Administration (TGA). The costs and resources required to successfully commercialize the vBloc System internationally are currently beyond our capability. Accordingly, we will continue to devote our near-term efforts toward mounting a successful system launch in the United States. We intend to explore select international markets to commercialize the vBloc System as our resources permit, using direct, dealer and distributor sales models as the targeted market best dictates.

To date, we have not observed any mortality related to our device or any unanticipated adverse device effects in our human clinical trials. We have also not observed any long-term problematic clinical side effects in any patients. In addition, data from our VBLOC-DM2 ENABLE trial outside the United States demonstrate that vBloc Therapy may hold promise in improving obesity-related comorbidities such as diabetes and hypertension. We are conducting, or plan to conduct, further studies in each of these comorbidities to assess vBloc Therapy’s potential in addressing multiple indications.

In 2016, we continued our commercialization efforts in the United States, deriving revenues from our primary business activity. We expect to incur significant sales and marketing expenses prior to recording sufficient revenue to offset these expenses. We expect our selling, general and administrative expenses to increase as we continue to add the infrastructure necessary to support our commercial sales, operate as a public company and develop our intellectual property portfolio. For these reasons, we expect to continue to incur operating losses$22.6 million for the next several years. full write-down of the ReShape Balloon product line assets disposed of. There was no income tax expense or benefit for discontinued operations.

Liquidity and Capital Resources

We have financed our operations to date principally through the sale of equity securities and debt financing and interest earned on investments.

financing.During 2016, our board of directors and stockholders approved two reverse stock splits (collectively, the Reverse Stock Splits). Neither reverse stock split changed the par value of our common stock or the number of preferred shares authorized by our certificate of incorporation.  The first reverse stock split was a 1-for-15 reverse split (the First Reverse Stock Split) of our outstanding common stock that became effective after trading on January 6, 2016.  The First Reverse Stock Split also decreased the number of shares of common stock authorized by our certificate of incorporation proportionately, and proportional adjustments were also made to our outstanding stock options and warrants and the number of shares authorized under our Amended and Restated 2003 Stock Incentive Plan . In connection with the First Reverse Stock Split, an amendment to our certificate of incorporation was also approved to increase the number of shares of our common stock authorized for issuance to 150 million shares, effective immediately after the First Reverse Stock Split on January 6, 2016.

The second reverse stock split was a 1-for-70 reverse split (the Second Reverse Stock Split) of our outstanding common stock that became effective after trading on December 27, 2016 pursuant to our Sixth Amended and Restated Certificate of Incorporation, which was filed in connection with the Second Reverse Stock Split. In connection with the Second Reverse Stock Split, proportional adjustments were also made to our outstanding stock options and warrants.  Additionally, in connection with the Second Reverse Stock Split, a second amendment was approved to increase the