UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
FORM 10-Q
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
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For the quarterly period ended SeptemberJune 30, 2019
2020
OR
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ___ to ___
Commission File Number 001-36305
SEMLER SCIENTIFIC, INC.
(Exact name of registrant as specified in its charter)
Delaware | 26-1367393 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification |
911 Bern Court, Suite 110San Jose, CA 95112
911 Bern Court, Suite 110 San Jose, CA95112 |
(Address of principal executive offices) (Zip Code) (877) 774-4211 |
(Registrant’s telephone number, including area code) |
(Address of principal executive offices) (Zip Code)
(877) 774-4211
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None.
Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
N/A | N/A | N/A |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx☒ No¨
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Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yesx☒ No¨
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.:Act:
Large Accelerated Filer | ☐ | Accelerated Filer | ☒ | ||||
Non-Accelerated Filer | ☐ | Smaller Reporting Company | ☒ | ||||
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Emerging growth company | ☐ | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨☐ Nox☒
As of November 1, 2019,August 5, 2020, there were 6,527,9166,563,176 shares of the issuer’s common stock, $0.001 par value per share, outstanding.
TABLE OF CONTENTS
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Management’s Discussion and Analysis of Financial Condition and Results of Operations | 12 | ||
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements.
These include risks relating to our strategy, our products and services, our preliminary estimates of variable-fee license revenues, as well as risks relating to the healthcare industry, a heavily regulated environment and the markets we and our customers operate in, including the ongoing COVID-19 pandemic.
In some cases, you can identify forward-looking statements by terminology, such as “expects,” “anticipates,” “intends,” “estimates,” “plans,” “believes,” “seeks,” “may,” “should,” “continue,” “could” or the negative of such terms or other similar expressions. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this report.
You should read this quarterly report and the documents that we reference herein and therein and have filed as exhibits to this report, completely and with the understanding that our actual future results may be materially different from what we expect. You should assume that the information appearing in this quarterly report is accurate as of the date of this report only. Because the risk factors referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statements. TheseThe risks and uncertainties, along with others, are described above under the heading “Risk Factors” in our annual report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 7, 2019.9, 2020, along with risks related to the ongoing COVID-19 pandemic and other risks could impact these forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We qualify all of the information presented in this quarterly report, and particularly our forward-looking statements, by these cautionary statements.
ii
PART I—FINANCIAL INFORMATION Semler Scientific, Inc. Condensed Statements of Income (In thousands of U.S. Dollars, except share and per share data) (unaudited) (unaudited) For the three months ended June 30 For the six months ended June 30 2020 2019 2020 2019 Revenue $ 6,373 $ 7,953 $ 15,803 $ 14,714 Operating expenses: Cost of revenue 700 885 1,550 1,781 Engineering and product development 762 591 1,605 1,160 Sales and marketing 2,473 2,212 5,168 4,281 General and administrative 1,478 1,570 3,069 2,943 Total operating expenses 5,413 5,258 11,392 10,165 Income from operations 960 2,695 4,411 4,549 Interest income (expense) 1 1 3 2 Other income (expense) 29 — 26 (2) Other expense 30 1 29 — Pre-tax net income $ 990 $ 2,696 $ 4,440 $ 4,549 Income tax (benefit) provision (85) 77 692 77 Net income 1,075 2,619 3,748 4,472 Net income per share, basic $ 0.16 $ 0.41 $ 0.57 $ 0.70 Weighted average number of shares used in computing basic income per share 6,548,215 6,411,606 6,540,755 6,368,905 Net income per share, diluted $ 0.13 $ 0.32 $ 0.47 $ 0.55 Weighted average number of shares used in computing diluted income per share 8,035,048 8,086,140 8,050,394 8,128,241 See accompanying notes to unaudited condensed financial statements. 1 Semler Scientific, Inc. (In thousands of U.S. Dollars, except share and per share data) (Unaudited) September 30, (unaudited) June 30, December 31, 2020 2019 Assets Current Assets: Cash $ 13,646 $ 7,741 Trade accounts receivable, net of allowance for doubtful accounts of $56 and $36 respectively 982 3,486 Prepaid expenses and other current assets 639 216 Total current assets 15,267 11,443 Assets for lease, net 1,928 2,079 Property and equipment, net 287 249 Long-term deposits — 15 Long-term deferred tax assets 3,905 4,501 Total assets $ 21,387 $ 18,287 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 207 $ 338 Accrued expenses 3,343 3,914 Deferred revenue 813 955 Other short-term liabilities 5 — Total current liabilities 4,368 5,207 Long-term liabilities: Deferred Lease — 7 Total long-term liabilities — 7 Stockholders’ equity: Common stock, $0.001 par value; 50,000,000 shares authorized; 6,588,176, and 6,556,221 shares issued, and 6,563,176 and 6,531,221 shares outstanding (treasury shares of 25,000, and 25,000, respectively) 7 7 Additional paid-in capital 19,598 19,400 Accumulated deficit (2,586) (6,334) Total stockholders’ equity 17,019 13,073 Total liabilities and stockholders’ equity $ 21,387 $ 18,287 See accompanying notes to unaudited condensed financial statements. 2 Semler Scientific, Inc. Statements of For the Three Months Ended June 30, 2019 Common Stock Treasury Stock Additional Common Stock Paid-In Accumulated Total Stockholder’s Shares Issued Amount Shares Amount Capital Deficit Equity / (Deficit) Balance at March 31, 2019 6,356,147 $ 6 (25,000) $ — $ 25,719 $ (19,565) $ 6,160 Warrant Re-purchase — — — — (2,687) — (2,687) Warrant Exercises 22,527 — — — — — — Stock Option Exercises 105,740 — — — 31 — 31 Stock-based Compensation — — — — 98 — 98 Net income — — — — — 2,619 2,619 Balance at June 30, 2019 6,484,414 $ 6 (25,000) $ — $ 23,161 $ (16,946) $ 6,221 For the Three Months Ended June 30, 2020 Common Stock Treasury Stock Additional Common Stock Paid-In Accumulated Total Stockholder’s Shares Issued Amount Shares Amount Capital Deficit Equity / (Deficit) Balance at March 31, 2020 6,559,076 $ 7 (25,000) $ — $ 19,470 $ (3,661) $ 15,816 Stock Option Exercises 29,100 — — — 67 — 67 Stock-based Compensation — — — — 61 — 61 Net income — — — — — 1,075 1,075 Balance at June 30, 2020 6,588,176 $ 7 (25,000) $ — $ 19,598 $ (2,586) $ 17,019 For the Six Months Ended June 30, 2019 Common Stock Treasury Stock Additional Common Stock Paid-In Accumulated Total Stockholder’s Shares Issued Amount Shares Amount Capital Deficit Equity / (Deficit) Balance at December 31, 2018 6,349,985 $ 6 (25,000) $ — $ 25,608 $ (21,418) $ 4,196 Warrant Re-purchase — — — — (2,687) — (2,687) Warrant Exercises 22,527 — — — — — — Stock Option Exercises 111,902 — — — 44 — 44 Stock-based Compensation — — — — 196 — 196 Net income — — — — — 4,472 4,472 Balance at June 30, 2019 6,484,414 $ 6 (25,000) $ — $ 23,161 $ (16,946) $ 6,221 For the Six Months Ended June 30, 2020 Common Stock Treasury Stock Additional Common Stock Paid-In Accumulated Total Stockholder’s Shares Issued Amount Shares Amount Capital Deficit Equity / (Deficit) Balance at December 31, 2019 6,556,221 7 (25,000) — 19,400 (6,334) 13,073 Stock Option Exercises 31,955 — — — 70 — 70 Stock-based Compensation — — — — 128 — 128 Net income — — — — — 3,748 3,748 Balance at June 30, 2020 6,588,176 $ 7 (25,000) $ — $ 19,598 $ (2,586) $ 17,019 3 Semler Scientific, Inc. Condensed Statements of Cash Flows (In thousands of U.S. Dollars) For the six months ended June 30 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 3,748 $ 4,472 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Depreciation 235 307 Deferred tax expense 596 — Loss on disposal of assets for lease 125 97 Allowance for bad debt 36 21 Stock-based compensation expense 128 196 Changes in Operating Assets and Liabilities: Trade accounts receivable 2,468 (730) Prepaid expenses and other assets (408) (60) Accounts payable (131) 125 Accrued expenses (573) (538) Deferred revenue (142) 493 Net Cash Provided by Operating Activities 6,082 4,383 CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (100) (63) Purchase of assets for lease (147) (779) Net Cash Used in Investing Activities (247) (842) CASH FLOWS FROM FINANCING ACTIVITIES: Re-purchase of warrants — (2,687) Exercise of stock option 70 44 Net Cash Provided by (Used in) Financing Activities 70 (2,643) INCREASE IN CASH 5,905 898 CASH, BEGINNING OF PERIOD 7,741 3,284 CASH, END OF PERIOD $ 13,646 $ 4,182 See accompanying notes to unaudited condensed financial statements 4 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) 1. Basis of Presentation Semler Scientific, Inc., a Delaware corporation (“Semler” or “the Company”), prepared the unaudited interim financial statements included in this report in accordance with United States generally accepted accounting principles (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, On January 30, 2020, the World Health Organization (“WHO”) declared the recent novel coronavirus (COVID-19) outbreak a global health emergency, which prompted national, state and local governments to begin putting actions in place to slow the spread of COVID-19. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic. The outbreak of COVID-19 has resulted in travel restrictions, quarantines, “stay-at-home” and “shelter-in-place” orders and extended shutdown of certain businesses around the world. For the three and six months ended June 30, 2020 the Company's revenues, primarily from variable-fee licenses were negatively impacted by the COVID-19 pandemic. The extent and duration of the pandemic is unknown, and the future effects on the Company's business are uncertain and difficult to predict. The Company is continuing to monitor the events and circumstances surrounding the COVID-19 pandemic, which may require adjustments to the Company's estimates and assumptions in the future. Recently Issued Accounting Pronouncements Accounting Pronouncements Recently Adopted In In June 2018, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) Accounting Pronouncements Not Yet Adopted In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“Topic 326”). This ASU requires timelier recording of credit losses on loans and other financial instruments held. Instead of reserves based on a current probability analysis, Topic 326 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. All organizations will now use forward-looking information to better inform their credit loss estimates. Topic 326 requires enhanced disclosures regarding significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide information about the amounts recorded in the financial statements. In addition, Topic 326 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326 Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, to introduce amendments which will affect the recognition and measurement of financial instruments, including derivatives and hedging. In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments – Credit Losses (Topic 326); Targeted Transition Relief. The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments upon adoption of Topic 326. This standard and related amendments are effective for the Company’s fiscal years beginning after December 15, 2022, including interim periods within those fiscal years. The Company will adopt the new standard in the first quarter of fiscal year In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing certain exceptions to the general principles for income taxes. This update is effective for the Company’s annual periods beginning after December 15, 2020, including interim periods within those fiscal years. The Company will adopt the new standard in the first quarter of fiscal year 2021. The Company does not anticipate this update to have a material impact on its financial statements. In January 2020, the FASB issued ASU No. 2020-01, Investments-Equity Securities (Topic 321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815). The amendments in this ASU clarify the interaction between the accounting for investments in equity securities, investment in equity method and certain derivatives instruments. The ASU is expected to reduce diversity in practice and increase comparability of the accounting for these interactions. This ASU is effective for fiscal years beginning after December 15, 2021. The adoption of this ASU is not expected to have any impact on the Company's results of operations, cash flows or financial position. In March 2020, FASB issued ASU No. 2020-03, Codification Improvements to Financial Instruments. This ASU improves and clarifies various financial instruments topics, including the current expected credit losses standard issued in 2016 (ASU No. 2016-13). The ASU includes seven different issues that describe the areas of improvement and the related amendments to GAAP, intended to make the standards easier to understand and apply by eliminating inconsistencies and providing clarifications. The amendments have different effective dates. The Company is evaluating the effect of adopting this new accounting guidance, but does not expect adoption will have a material impact on the Company's financial statements. In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional expedient and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. In response to the concerns about structural risks of interbank offered rates (IBORs) and, particularly, the risk of cessation of the London Interbank Offered Rate (LIBOR), regulators in several jurisdictions around the world have undertaken reference rate reform initiatives to identify alternative reference rates that are more observable or transaction-based and less susceptible to manipulation. The ASU provides companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to be discontinued. The ASU can be adopted no later than December 1, 2022, with early adoption permitted. The Company has not yet adopted this ASU and is evaluating the effect of adopting this new accounting guidance. 6 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) 2. Variable-fee Revenue Topic 606 affects revenue recognition for the Company’s variable-fee licenses (i.e., fee per test) and sales of hardware equipment and accessories. Total fees from variable-fee licenses represent approximately $290 and $2,250 of revenues for the three months ended June 30, 2020 and 2019, respectively. Total fees from variable-fee licenses represent approximately $2,992 and $3,506 for the six months ended June 30, 2020 and 2019, respectively. Total sales of hardware and equipment accessories represent approximately $129 and $307 of revenues for the three months ended June 30, 2020 and 2019, respectively. Total sales of hardware and equipment accessories represent approximately $400 and $552 of revenues for the six months ended June 30, 2020 and 2019, respectively. Essentially all of the variable-fee licenses are with large healthcare organizations. The remainder of the revenue is earned from leasing the Company's testing product for a fixed fee, which is not subject to Topic 606. 3. Assets for Lease, net The Company enters into contracts with customers for the Company’s QuantaFlo® product. The Company has determined these contracts meet the definition of a lease under Topic 842. The lease portfolio primarily consists of operating leases that are short-term in nature (monthly, quarterly or one year, all of which have renewal options). The assets associated with these leasing arrangements are identified below as assets for lease. During the three months ended June 30, 2020 and 2019, the Company recognized approximately $5,954 and $5,396, respectively, in lease revenues related to these arrangements. During the six months ended June 30, 2020 and 2019, the Company recognized approximately $12,411 and $10,656, respectively, in lease revenues related to these arrangements, which is included in Revenues on the Condensed Statements of Income. Assets for lease consist of the following: June 30, December 31, 2020 2019 $ 3,308 $ 3,374 (1,380) (1,295) $ 1,928 $ 2,079 Depreciation expense amounted to 4. Property and Equipment, net Capital assets consist of the following: June 30, December 31, 2020 2019 $ 737 $ 636 (450) (387) $ 287 $ 249 Depreciation expense amounted to 7 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) Accrued expenses consist of the following: June 30, December 31, 2020 2019 $ 2,365 $ 2,803 Accrued taxes 615 378 363 733 $ 3,343 $ 3,914 6. Concentration of Credit Risk Credit risk is the risk of loss from amounts owed by the financial counterparties. Credit risk can occur at multiple levels; as a result of broad economic conditions, challenges within specific sectors of the economy, or from issues affecting individual companies. Financial instruments that potentially subject the Company to credit risk consist of cash and accounts receivable. The Company maintains cash with major financial institutions. The Company’s cash consists of bank deposits held with banks that, at times, exceed federally insured limits. The Company limits its credit risk by dealing with counterparties that are considered to be of high credit quality and by performing periodic evaluations of the relative credit standing of these financial institutions. Management periodically monitors the creditworthiness of its customers and believes that it has adequately provided for any exposure to potential credit loss. For the three months ended As of December 31, 7. Commitments and Contingencies Facilities Leases The Company recognized facilities lease expenses of 8 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and Indemnification Obligations The Company enters into agreements with customers, partners, lenders, consultants, lessors, contractors, sales representatives and parties to certain transactions in the ordinary course of the Company’s business. These agreements may require the Company to indemnify the other party against third party claims alleging that its product infringes a patent or copyright. Certain of these agreements require the Company to indemnify the other party against losses arising from: a breach of representations or covenants, claims relating to property damage, personal injury or acts or omissions of the Company, its employees, agents or representatives. The Company has also agreed to indemnify the directors and certain of the officers and employees in accordance with the by-laws of the Company. These indemnification provisions will vary based upon the nature and terms of the agreements. In many cases, these indemnification provisions do not contain limits on the Company’s liability, and the occurrence of contingent events that will trigger payment under these indemnities is difficult to predict. As a result, the Company cannot estimate its potential liability under these indemnities. The Company believes that the likelihood of conditions arising that would trigger these indemnities is remote and, historically, the Company The Company’s stock-based compensation program is designed to attract and retain employees while also aligning 2020. In light of stockholder approval of the 2014 Plan, the Company no longer grants equity awards under the 2007 Plan. As of 9 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) Aggregate intrinsic value represents the difference between the closing market value as of Options Outstanding Weighted Number of Weighted Average Stock Average Remaining Aggregate Options Exercise Contractual Intrinsic Value Outstanding Price Term (In Years) (in thousands) Balance, January 1, 2020 1,581,582 $ 3.23 5.86 $ 70,827 Options exercised (32,567) 3.01 — — Balance, June 30, 2020 1,549,015 $ 3.23 5.37 $ 66,248 Exercisable as of June 30, 2020 1,482,272 $ 3.10 5.28 $ 63,588 The total compensation cost related to unvested stock option awards not yet recognized was 2019. The Company has recorded an expense of$ Three months ended June 30, Six months ended June 30, 2020 2019 2020 2019 Cost of Revenue $ — $ 1 $ — $ 1 Engineering and Product Development — 5 — 12 Sales and Marketing — 15 — 31 General and Administrative 61 77 128 152 Total $ 61 $ 98 $ 128 $ 196 9.Income Taxes The Company’s income tax provision for the three and six months ended June 30, 2020 and June 30, 2019, respectively, reflects its estimate of the effective tax rates expected to be applicable for the full year, adjusted for any discrete events that are recorded in the period in which they occur. The estimates are re-evaluated each quarter based on the estimated tax expense for the full year. The effective tax rate for the three and six months ended June 30, 2020 was (8.59%) and 15.59%, respectively, compared to 2.86% and 1.69%, respectively, in the same periods of the prior year. The increase in the effective tax rate for the six months ended June 30, 2020 is primarily related to the release of the entire valuation allowance against the deferred tax assets for federal and state net operating loss (“NOL”) carryforwards and other related deferred tax assets in quarter ended September 30, The effective tax rate for the three and 10 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) respectively, was primarily due to NOL carryforwards that offset potential current taxes for which a full valuation allowance had been previously provided. On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act was signed into law. The Company has evaluated the impact of the new regulations and determined that there is no material impact to its financial statements. 10. Net Income Per Share, Basic and Diluted Basic earnings per share (“EPS”) represent net income attributable to common stockholders divided by the weighted average number of common shares outstanding during the measurement period. Diluted EPS represents net income attributable to common stockholders divided by the weighted average number of common shares outstanding during the measurement period while also giving effect to all potentially dilutive common shares that were outstanding during the period using the treasury stock method. Basic and diluted EPS is calculated as follows: Three months ended June 30, 2020 2019 Shares Net Income EPS Shares Net Income EPS Basic 6,548,215 $ 1,075 $ 0.16 6,411,606 $ 2,619 $ 0.41 69,039 — 168,099 — 1,417,794 — 1,506,435 — Diluted 8,035,048 $ 1,075 $ 0.13 8,086,140 $ 2,619 $ 0.32 Six months ended June 30, 2020 2019 Shares Net Income EPS Shares Net Income EPS Basic 6,540,755 $ 3,748 $ 0.57 6,368,905 $ 4,472 $ 0.70 69,377 — 207,471 — 1,440,262 — 1,551,865 — Diluted 8,050,394 $ 3,748 $ 0.47 8,128,241 $ 4,472 $ 0.55 11.Subsequent Events 11 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis should be read together with our condensed unaudited financial statements and the related notes appearing elsewhere in this quarterly report on Form 10-Q and with the audited financial statements and notes for the fiscal year ended December 31, Overview We are In the three months ended Recent Developments We believe that as such restrictions are lifted around the country and non-emergency medical services are resumed, our business will return to pre-COVID-19 levels. We may also experience even higher test volumes if our customers accelerate usage due to a backlog of untested patients. However, we cannot be certain that this will occur, nor is there certainty that the recent roll-back in restrictions will be maintained. New, additional, or different restrictions could be imposed, which could impact the usage of our product by our customers. Other customers (who have fixed-fee licenses) could decide to cancel their licenses if they are not able to use our device as frequently as they had anticipated in light of such restrictions. Although we do not provide formal guidance, we intend to manage our expenses and other costs in line with changes in revenues to conservatively preserve cash during these uncertain times. To date, we have maintained staffing, salaries and inventory at usual levels, and travel expenses have decreased. We expect that 12 Results of Operations Three Months Ended Revenues We had revenues of Revenues from fees for vascular testing products are recognized monthly for each unit installed with a customer, Operating expenses We had total operating expenses of Cost of revenues We had cost of revenues of Engineering and product development expense We had engineering and product development expense of Sales and marketing expense We had sales and marketing expense of $2,473,000 for the three months ended June 30, 2020, an increase of $261,000, or 12%, compared to $2,212,000 in the same period of the prior year. The increase was primarily due to higher personnel expense associated with the continued expansion of existing customers, education, training, and associated expense, partially offset by lower travel expenses. As a percentage of revenues, sales and marketing expense increased to 39% in the second quarter of 2020, as compared to 28% in the prior year period. 13 General and administrative expense We had general and administrative expense of $1,478,000 for the three months ended June 30, 2020, a decrease of $92,000, or 6%, compared to $1,570,000 in the same period of the prior year. The decrease was primarily due to lower professional fees, partially offset by increased expenses to support a growing company, including higher infrastructure costs, insurance and other consultants’ fees. As a percentage of revenues, general and administrative expense increased to 23% in the second quarter of 2020, as compared to 20% in the prior year period. Other income We had other income of $30,000 for the three months ended June 30, 2020, compared to other income of $1,000 in the same period of the prior year. The increase was primarily due to miscellaneous income and interest income, partially offset by credit card merchant fees. Pre-tax net income For the foregoing reasons, we had pre-tax net income of $990,000, for the three months ended June 30, 2020, a decrease of $1,706,000, or 63%, compared to a pre-tax net income of $2,696,000 for the same period of the prior year. Income tax expense (benefit) We had income tax benefit of $85,000 for the three months ended June 30, 2020, compared to income tax expense of $77,000 in the same period of the prior year. The benefit was primarily due to discrete events that occurred during the quarter. Net income For the foregoing reasons, we had net income of $1,075,000, or $0.16 per basic share and $0.13 per diluted share, for the three months ended June 30, 2020, an decrease of $1,544,000, or 59%, compared to a net income of $2,619,000, or $0.41 per basic share and $0.32 per diluted share, for the same period of the prior year. Six Months Ended June 30, 2020 Compared to Six Months Ended June 30, 2019 Revenues We had revenues of $15,803,000 for the six months ended June 30, 2020, an increase of $1,089,000, or 7%, compared to $14,714,000 in the same period in 2019. Our revenues are primarily from fees charged to customers for use of our vascular testing products and from sale of accessories used with these products. We recognized revenues of $15,403,000 from fees for our vascular testing products for the six months ended June 30, 2020, an increase of $1,241,000 compared to $14,162,000 in the same period of the prior year, which is primarily due to an overall increase in our customer base with fixed-fee licenses, which offset the negative effects of the COVID-19 pandemic. Fixed-fee license revenues were approximately $12,411,000, an increase of $1,754,000, or 16%, variable-fee license revenues were approximately $2,992,000. The remainder of our revenues was from other items, such as Revenues from fees for vascular testing products are recognized monthly for each unit installed with a customer, usually billed as a monthly fixed-fee or as a monthly variable-fee dependent on Operating expenses We had total operating expenses of $11,392,000 for the six months ended June 30, 2020, an increase of $1,227,000 or 12%, compared to $10,165,000 in the same period in the prior year. The primary reason for this change was overall growth in our business, increased compensation of the sales team and increased headcount of field sales and technical support personnel to service the expanding number of customers, which offset the decrease in cost of revenues. As a percentage of revenues, operating expenses increased to 72% in the first half of 2020 as compared to 69% in the prior year period. The changes in the various components of our operating expenses are described below. 14 Cost of revenues We had cost of revenues of $1,550,000 for the six months ended June 30, 2020, a decrease of $231,000, or 13%, compared to $1,781,000 in the same period of the prior year. The primary reason for this change was decreased headcount and lower depreciation per unit per month as a greater percentage of installations were software and sensor only, rather than laptop, software and sensor. As a percentage of revenues, cost of revenues decreased to 10% in the first half of 2020, as compared to 12% in the prior year period, primarily due to revenues growing at a faster pace than cost of revenues. Engineering and product development expense We had engineering and product development expense of $1,605,000 for the six months ended June 30, 2020, an increase of $445,000, or 38%, compared to $1,160,000 in the same period of the prior year. The increase was primarily due to increased personnel and other costs associated with our product development and customization Sales and marketing expense We had sales and marketing expense of General and administrative expense We had general and administrative expense of Other income We had Pre-tax net income For the foregoing reasons, we had pre-tax net income of $4,440,000, for the six months ended June 30, 2020, a decrease of $109,000, or 2%, compared to a pre-tax net income of $4,549,000 for the same period of the prior year. Income tax expense We had Net income For the foregoing reasons, we had net income of 15 Liquidity and Capital Resources We had cash of Our cash is held in a variety of non-interest bearing bank accounts. We may also hold interest-bearing instruments subject to investment guidelines allowing for holdings in U.S. government and agency securities, corporate securities, taxable municipal bonds, commercial paper and money market accounts. In addition, we may also choose to invest some of our cash resources in other entities that may have complementary technologies or product offerings. Operating activities We generated Investing activities We used We used $842,000 of net cash in investing activities for the six months ended June 30, 2019, which reflects purchases of assets for lease of Financing activities We generated $70,000 in net cash from financing activities during the six months ended June 30, 2020, primarily due to proceeds from exercise of stock options. We used Off-Balance Sheet Arrangements As of each of Commitments and Contingencies As of each of Item 3. Quantitative and Qualitative Disclosures About Market Risk. Not applicable. 16 Item 4. Controls and Procedures. Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure material information required to be disclosed in our reports that we file or submit under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance, as appropriate, to allow timely decisions regarding required financial disclosure. In designing and evaluating the disclosure controls and procedures, Under the supervision of and with the participation of our We previously identified the following material weaknesses in internal control over financial reporting as of the Each of the Changes in Internal Control over Financial Reporting None. Not applicable. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None. Item 3. Defaults Upon Senior Securities. None. Item 4. Mine Safety Disclosures. Not applicable. Not applicable. Exh. No. Exhibit Name 31.1 Rule 13a-14(a) Certification of Principal Executive Officer of Registrant 31.2 Rule 13a-14(a) Certification of Principal Financial Officer of Registrant 32.1 101.INS XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. 101.SCH Inline XBRL Taxonomy Extension Schema 101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase 101.DEF Inline XBRL Taxonomy Extension Definition Linkbase 101.LAB Inline XBRL Taxonomy Extension Label Linkbase 101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase 104 The cover page from Semler Scientific's Quarterly Report on Form 10-Q for the three months ended June 30, 2020 is formatted in Inline XBRL and it is contained in Exhibit 101 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. August 6, SEMLER SCIENTIFIC, INC. By: /s/ Douglas Murphy-Chutorian, M.D. Douglas Murphy-Chutorian, M.D. Chief Executive Officer By: /s/ Andrew B. Weinstein Andrew B. Weinstein Senior Vice President, Finance and Accounting 19 (Unaudited) (Unaudited) For the three months ended September 30 For the nine months ended September 30 2019 2018 2019 2018 Revenues $ 8,902 $ 5,579 $ 23,616 $ 15,526 Operating expenses: Cost of revenues 974 615 2,755 1,999 Engineering and product development 617 587 1,777 1,443 Sales and marketing 2,345 1,798 6,626 5,283 General and administrative 1,855 1,033 4,798 2,908 Total operating expenses 5,791 4,033 15,956 11,633 Income from operations 3,111 1,546 7,660 3,893 Interest expense (2 ) (1 ) - (57 ) Related party interest expense - (74 ) - (206 ) Other expense (1 ) (3 ) (3 ) (4 ) Other expense (3 ) (78 ) (3 ) (267 ) Income before income taxes 3,108 1,468 7,657 3,626 Income tax (benefit) provision (4,671 ) - (4,594 ) - Net income $ 7,779 $ 1,468 $ 12,251 $ 3,626 Net income per share: Basic $ 1.20 $ 0.24 $ 1.91 $ 0.60 Diluted $ 0.96 $ 0.19 $ 1.51 $ 0.48 Weighted average number of shares used in computing: basic and diluted income per share Basic 6,492,501 6,086,489 6,410,588 5,998,460 Diluted 8,108,053 7,927,788 8,121,996 7,611,961 December 31, 2019 2018 Assets Current Assets: Cash $ 8,542 $ 3,284 Trade accounts receivable, net of allowance for doubtful accounts of $36 and $52, respectively 3,271 2,801 Prepaid expenses and other current assets 274 153 Total current assets 12,087 6,238 Assets for lease, net 1,826 1,243 Property and equipment, net 220 223 Long-term deposits 15 15 Long-term deferred tax assets 4,709 - Total assets $ 18,857 $ 7,719 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 669 $ 280 Accrued expenses 2,909 2,797 Deferred revenue 1,169 435 Total current liabilities 4,747 3,512 Long-term liabilities: Deferred rent 8 11 Total long-term liabilities 8 11 Stockholders' equity: Common stock, $0.001 par value; 50,000,000 shares authorized; 6,552,916 and 6,349,985 shares issued, and 6,527,916 and 6,324,985 outstanding (treasury shares of 25,000 and 25,000), respectively 7 6 Additional paid-in capital 23,262 25,608 Accumulated deficit (9,167 ) (21,418 ) Total stockholders' equity 14,102 4,196 Total liabilities and stockholders' equity $ 18,857 $ 7,719 Stockholders'Stockholders’ Equity (Deficit) (In(In thousands of U.S. Dollars, except share and per share data) For the Three Months Ended September 30, 2018 Common Stock Treasury Stock Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Total
Stockholder's
Equity Balance at June 30, 2018 6,048,397 $ 6 (25,000 ) $ - $ 24,484 $ (24,274 ) $ 216 Issuance of Common Stock 12,943 - - - 294 - 294 Warrant Exercises 26,139 - - - - - - Stock Option Exercises 110,815 - - - 195 - 195 Stock-based Compensation - - - - 139 - 139 Net income for three months ended September 30, 2018 - - - - - 1,468 1,468 Balance at September 30, 2018 6,198,294 $ 6 (25,000 ) $ - $ 25,112 $ (22,806 ) $ 2,312 For the Three Months Ended September 30, 2019 Common Stock Treasury Stock Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Total
Stockholder's
Equity Balance at June 30, 2019 6,484,414 $ 6 (25,000 ) $ - $ 23,161 $ (16,946 ) $ 6,221 Warrant Exercises 13,670 - - - - - - Stock Option Exercises 54,832 1 - - 15 - 16 Stock-based Compensation - - - - 86 - 86 Net income for three months ended September 30, 2019 - - - - - 7,779 7,779 Balance at September 30, 2019 6,552,916 $ 7 (25,000 ) $ - $ 23,262 $ (9,167 ) $ 14,102 See accompanying notes to unaudited condensed financial statements.For the Nine Months Ended September 30, 2018 Common Stock Treasury Stock Total Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Stockholder's
Equity /
(Deficit) Balance at December 31, 2017 5,902,244 $ 6 (25,000 ) $ - $ 23,843 $ (26,432 ) $ (2,583 ) Issuance of Common Stock 12,943 - - - 294 - 294 Warrant Exercises 66,914 - - - 64 - 64 Stock Option Exercises 216,193 - - - 440 - 440 Stock-based Compensation - - - - 471 - 471 Net income for nine months ended September 30, 2018 - - - - - 3,626 3,626 Balance at September 30, 2018 6,198,294 $ 6 (25,000 ) $ - $ 25,112 $ (22,806 ) $ 2,312 For the Nine Months Ended September 30, 2019 Common Stock Treasury Stock Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Total
Stockholder's
Equity Balance at December 31, 2018 6,349,985 6 (25,000 ) - 25,608 (21,418 ) 4,196 Warrant Repurchase - - - - (2,687 ) - (2,687 ) Warrant Exercises 36,197 - - - - - - Stock Option Exercises 166,734 1 - - 59 - 60 Stock-based Compensation - - - - 282 - 282 Net income for nine months ended September 30, 2019 - - - - - 12,251 12,251 Balance at September 30, 2019 6,552,916 $ 7 (25,000 ) $ - $ 23,262 $ (9,167 ) $ 14,102 See accompanying notes to unaudited condensed financial statements.4 (Unaudited)
Nine months ended September 30 2019 2018 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 12,251 $ 3,626 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Amortization of debt discount - 22 Accretion of non-cash interest - 200 Depreciation 470 373 Deferred income tax (4,709 ) - Loss on disposal of property and equipment - 2 Loss on disposal of assets for lease 159 150 Bad debt expense 42 39 Stock-based compensation expense 282 470 Changes in Operating Assets and Liabilities: Trade accounts receivable (512 ) (1,165 ) Prepaid expenses and other assets (122 ) (60 ) Accounts payable 389 (237 ) Accrued expenses 109 (609 ) Deferred revenue 734 (160 ) Net Cash Provided by Operating Activities 9,093 2,651 CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (106 ) (131 ) Proceeds from disposal of property and equipment - 1 Purchase of assets for lease, net (1,102 ) (323 ) Net Cash Used in Investing Activities (1,208 ) (453 ) CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of warrants (2,687 ) - Exercise of warrants - 64 Exercise of stock options 60 440 Payments of loans payable - (1,072 ) Net Cash Used in Financing Activities (2,627 ) (568 ) INCREASE IN CASH 5,258 1,630 CASH, BEGINNING OF PERIOD 3,284 1,457 CASH, END OF PERIOD $ 8,542 $ 3,087 Cash paid for interest $ - $ 192 Retirement of related party loans payable through common stock issuance $ - $ 294 5Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)1.Basis of Presentation20182019 filed with the SEC on March 7, 20199, 2020 (the “Annual Report”). In the opinion of management, these financial statements include all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the financial position, results of operations and cash flows for the periods presented. The results of operations for the interim periods shown in this report are not necessarily indicative of the results that may be expected for any future period, including the full year.May 2014,November 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting StandardStandards Update (“ASU”) No. 2014-09,2019-08 – Compensation – Stock Compensation (Topic 718) and Revenue from Contracts with Customers (“ASU No. 2014-09”)Customer (Topic 606). The amendment in this ASU provides guidanceamendments on the revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The core principle of this update provides guidancerequire that an entity measure and classify share-based payment awards granted to identify the performance obligations under the contract(s) with a customer and how to allocateby applying the guidance in Topic 718. The amount recorded as a reduction in the transaction price toshould be based on the performance obligations ingrant-date fair value of the contract. It further provides guidance to recognize revenue when (or as) the entity satisfies a performance obligation.share-based payment award. This standard replaced most existing revenue recognition guidance. On August 8, 2015,is effective for the FASB issued ASU 2015-14, which deferred the effective date of ASU No. 2014-09 by one year, and permits early adoption as long as the adoption date is not before the original public entity effective date. Since the issuance of ASU 2014-09, the FASB has issued several amendments that clarify certain points,Company’s annual periods beginning after December 15, 2019 , including ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing (“Topic 606”), ASU 2016-11, Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 Emerging Issues Task Force Meeting, and ASU 2016-12, Narrow-Scope Improvements and Practical Expedients, and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606. The updated revenue standard allows two methods of adoption: (1) retrospectively to each prior period presented (“full retrospective method”), or (2) retrospectively with the cumulative effect recognized in retained earnings as of the date of adoption (“modified retrospective method”). The new standard further requires new disclosures about contracts with customers, including the significant judgments the company has made when applying the guidance.interim periods within those fiscal years. The Company adopted the new standard effectiveon January 1, 2019, using the modified retrospective method. The Company2020 and determined that the adoption of this new standardaccounting guidance did not have a material impact on its financial statements.Topic 606 affects revenue recognition for the Company’s variable license fee contracts, which represents approximately $2,660 and $1,375 of revenues for the three-month periods ended September 30, 2019 and 2018, respectively, and approximately $6,166 and $3,384 of revenues for the nine-month periods ended September 30, 2019 and 2018, respectively. Essentially all of the variable license fee contracts are with large healthcare organizations. The remainder of the revenue is earned from leasing the Company's testing product for a fixed monthly fee, which is not subject to Topic 606. It was determined that the impact of the new standard has no effect on the way revenue was currently being recognized. Reusable hardware equipment or accessories may be provided to a customer for a set price and then use of the associated software is billed to the customer monthly based on volume of use. Under this scenario, revenue is recognized when and only when the customer uses the product. The Company is rendering a service and recognizes revenue in direct proportion to how much service is rendered. The sale of the equipment or accessories is recognized as hardware sales upon shipment to the customer. The initial contract is for a specified time period with automatic renewal each period thereafter until canceled. In case there is a violation of any term of the contract, the Company may deactivate the service remotely, so that the customer cannot continue to use the product.6Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)Accounting Pronouncements Not Yet AdoptedIn January 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU No. 2016-02”). Under the new guidance in ASU No. 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: 1) A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and 2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged, however, certain targeted improvements were made. ASU No. 2016-02 also simplifies the accounting for sale and leaseback transactions. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Lessees and lessors may not apply a full retrospective transition approach. The new standard also requires expanded disclosures regarding leasing arrangements. In July 2018, the FASB issued ASU No. 2018-11, Leases (Topic 842): Targeted Improvements (“ASU No. 2018-11”). ASU No. 2018-11 provides another transition method in addition to the existing transition method by allowing entities to initially apply the new leases standard at the adoption date and recognize a cumulative effect adjustment to the opening balance of retained earnings in the period of adoption. This ASU also provides further guidance on lessors accounting policy election to not separate non-lease components from the associated lease components and limits this to circumstances in which the non-lease component or components otherwise would be accounted for under the new revenue guidance and both (1) the timing and pattern of transfer are the same for the non-lease component(s) and associated lease component, and (2) the lease component, if accounted for separately, would be classified as a an operating lease. In December 2018, the FASB issued ASU No. 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors. This ASU provide narrow scope improvements for lessor accounting by permitting lessors, as an accounting policy election, to treat certain sales taxes and other similar taxes as lessee costs, to exclude lessor costs paid by lessees directly to third parties from variable payments, and clarify the accounting by lessors for variable payments that related to both a lease component and a non-lease component. In January 2019, the FASB issued ASU No. 2019-01, Leases Codification Improvements, which reinstates the exception for lessors that are not manufacturers or dealers for determining fair value of the leased property as the underlying asset’s cost, clarifies the presentation on the statement of cash flows for sales type and direct financing leases for lessors that are depository and lending institutions and clarifies the transition disclosures related to accounting changes and error corrections in the year of adoption of the ASU. The Company will adopt the new standard on December 31, 2019 upon expiration of their status as an emerging growth company using the modified retrospective approach and the optional transition method under ASU No. 2018-11. The Company evaluated the impact of the new accounting standard on its lease contracts with customers and determined that there will be no impact to the accounting and revenue recognition under these lease contracts with customers. As for leases for which the Company is the lessee, management reviewed its lease obligations and determined that the Company generally does not enter into long-term lease obligations with the exception of its office leases. The Company is a lessee on certain real estate leases that will need to be reported as right of use assets and liabilities related to these leases in the Company’s financial statements on the date of adoption. The Company is in the process of determining the amounts to be recorded on adoption related to these leases and does not anticipate that adoption of this new standard will have a material impact on its financial statements.In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“Topic 326”). This ASU requires timelier recording of credit losses on loans and other financial instruments held. Instead of reserves based on a current probability analysis, Topic 326 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. All organizations will now use forward-looking information to better inform their credit loss estimates. Topic 326 requires enhanced disclosures regarding significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide information about the amounts recorded in the financial statements. In addition, Topic 326 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. In April 2019, the FASB issued ASU2019-04 Codification Improvements to Topic 326, Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments to introduce amendments which will affect the recognition and measurement of financial instruments, including derivatives and hedging. In May 2019, the FASB issued ASU 2019-05, Financial Instruments – Credit Losses (Topic 326); Targeted Transition Relief. The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments upon adoption of Topic 326. This standard and related amendments are effective for the Company’s fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company will adopt the new standard in the first quarter of fiscal year 2020. The Company does not anticipate this new standard will have a material impact on its financial statements. (“ASU 2018-07”). This ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of costs. The ASU specifies that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. This standard is effective for the Company’s annual periods beginning after December 15, 2019, including interim periods within those fiscal years. The Company will adoptadopted the new standard inon January 1, 2020 and determined that the first quarteradoption of fiscal year 2020. The Company does not anticipatethis this new standard willaccounting guidance did not have a material impact on its financial statements.7Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)Measurement.Measurement. The amendments in this ASU modify the disclosure requirements on fair value measurements removing the requirements to disclosure amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels, and the valuation processes for Level 3 fair value measurements. In addition, it modified certain disclosures related to Level 3 fair value measurements and added additional disclosures regarding the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period. This update is effective for the Company’s annual periods beginning after December 15, 2019, including interim periods within those fiscal years. The Company adopted the new standard on January 1, 2020 and determined that the adoption of this this new accounting guidance did not have a material impact on its financial statements.2020.2023. The Company does not anticipate this new standard will have a material impact on its financial statements.2.Assets for Lease, net September 30,
2019 December 31,
2018 Assets for lease $ 3,047 $ 2,218 Less: accumulated depreciation (1,221 ) (975 ) Assets for lease, net $ 1,826 $ 1,243 $124$44 and $97$126 for the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. Depreciation expense amounted to $361$172 and $296$236 for the ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. Reduction to accumulated depreciation for returned items was $38$22 and $24$42 for the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. Reduction to accumulated depreciation for returned items was $115$87 and $85$77 for the ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. The Company recognized a loss on disposal of assets for lease in the amount of $62$59 and $43$63 for the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. The Company recognized a loss on disposal of assets for lease in the amount of $159$125 and $150$97 for the ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, respectively.3. September 30,
2019 December 31,
2018 Capital assets $ 563 $ 457 Less: accumulated depreciation (343 ) (234 ) Capital assets, net $ 220 $ 223 $38$32 and $27$37 for the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. Depreciation expense amounted to $109$63 and $77$71 for the ninesix months ended SeptemberJune 30, 20192020 and 2018,2019, respectively.8Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)4.5. Accrued Expenses September 30,
2019 December 31,
2018 Compensation $ 2,344 $ 2,442 Accrued Taxes 185 81 Miscellaneous accruals 380 274 Total accrued expenses $ 2,909 $ 2,797 5.SeptemberJune 30, 2018, two2019, 3 customers accounted for 51.8%50.8%, 14.8% and 22.2%13.8% of the Company’s revenue,revenues, respectively. For the ninesix months ended SeptemberJune 30, 2018, two2019, 3 customers accounted for 53.1%53.0%, 13.2%, and 19.4%11.1% of the Company’s revenue,revenues, respectively. For the three months ended SeptemberJune 30, 2019, three2020, 1 customer accounted for 62.1% of the Company’s revenues. For the six months ended June 30, 2020, 2 customers accounted for 47.0%, 15.7%52.5% and 12.4%14.0% of the Company’s revenue, respectively. For the nine months ended September 30, 2019, three customers accounted for 50.7%, 12.9% and 12.8% of the Company’s revenue,revenues, respectively. As of December 31, 2018, two2019, 3 customers accounted for 43.5%55.9%, 17.6% and 40.4%12.0% of the Company’s accounts receivable, respectively. As of SeptemberJune 30, 2019, three2020, 3 customers accounted for 30.8%33.0%, 22.6%12.1% and 16.6%10.6% of the Company’s accounts receivable, respectively.The Company’s largest customer in terms of both revenues forand accounts receivable in the three months ended SeptemberJune 30, 2019 and accounts receivable as of September 30, 20192020 is a U.S. diversified healthcare company and its affiliated plans.2018, two2019, 3 vendors accounted for 11.0%23.3%, 20.3% and 10.8%11.1% of the Company’s accounts payable, respectively. As of SeptemberJune 30, 2019, four2020, 2 vendors accounted for 15.4%, 12.3%, 10.9%11.4%, and 10.3% of the Company’s accounts payable, respectively.6.$17$18 and $17 for the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. The Company recognized facilities lease expenses of $51$35 and $52$34 for the ninesix months ended SeptemberJune 30, 2020 and 2019, respectively.2018, respectively.per share data)hadhas not made any significant payment under such indemnification provisions. Accordingly, the Company has not recorded any liabilities relating to these agreements. In certain cases, the Company has recourse against third parties with respect to the aforesaid indemnities, and the Company believes it maintains adequate levels of insurance coverage to protect the Company with respect to potential claims arising from such agreements.9Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)7.Warrant Repurchase – Related PartyOn May 3, 2019, the Company entered into a Warrant Repurchase Agreement with the Murphy-Chutorian Family Trust U/D/T dated January 13, 1997, of which Douglas Murphy-Chutorian, M.D., the Company’s director and chief executive officer is co-Trustee with his spouse and of which he is a beneficiary. Pursuant to the warrant repurchase agreement, the Company repurchased a warrant to acquire 65,542 shares of the Company’s common stock held by the trust, which warrant had an exercise price equal to $4.50 per share and an expiration date of July 31, 2023, at an aggregate purchase price of $2,687. The purchase price reflects the difference between the aggregate exercise price of the warrant and the aggregate fair market value of the shares underlying the warrant, based on the last trade price of the Company’s common stock on May 3, 2019, the date of the warrant repurchase agreement. Following the warrant repurchase, the warrant was cancelled and is no longer issued and outstanding.8.8. Stock Option Plan employees'employees’ interests with the interests of its stockholders. Stock options have been granted to employees under the stockholder-approved 2007 Key Person Stock Option Plan (“2007 Plan”) or the stockholder-approved 2014 Stock Incentive Plan (“2014 Plan”). Stockholder approval of the 2014 Plan became effective in September 2014. The 2014 Plan originally provided that the aggregate number of shares of common stock that may be issued pursuant to awards granted under the 2014 Plan may not exceed 450,000 shares (the “Share Reserve”), however in October 2015, the stockholders approved a 1,500,000 increase to the Share Reserve. In addition, the Share Reserve automatically increases on January 1st of each year, for a period of not more than 10 years, beginning on January 1st of the year following the year in which the 2014 Plan became effective and ending on (and including) January 1, 2024, in an amount equal to 4% of the total number of shares of common stock outstanding on December 31st of the preceding calendar year. The Company’s Board of Directors may act prior to January 1st of a given year to provide that there will be no January 1st increase in the Share Reserve for such year or that the increase in the Share Reserve for such year will be a lesser number of shares of common stock than would otherwise occur. On January 1, 2015,2020, the Share Reserve increased by 188,640 shares due to the automatic 4% increase. On January 1, 2016, the Share Reserve increased by 204,943 shares due to the automatic 4% increase. On January 1, 2017, the Share Reserve increased by 204,943 shares due to the automatic 4% increase. On January 1, 2018, the Share Reserve increased by 235,090261,249 shares due to the automatic 4% increase. The Share Reserve is currently 2,783,616 shares as of SeptemberJune 30, 2019.SeptemberJune 30, 2019,2020, 0 shares of an aggregate total of 407,500 shares were available for future stock-based compensation grants under the 2007 Plan and 996,9681,258,557 shares of an aggregate total of 2,783,616 shares were available for future stock-based compensation grants under the 2014 Plan.SeptemberJune 30, 20192020 of the underlying common stock and the exercise price of outstanding, in-the-money options. A summary of the Company’s stock option activity and related information for the ninesix months ended SeptemberJune 30, 20192020 is as follows: Options Outstanding Number of
Stock Options
Outstanding Weighted
Average
Exercise Price Weighted
Average
Remaining
Contractual
Term (In Years) Aggregate
Intrinsic Value
(in thousands) Balance, January 1, 2019 1,761,447 $ 3.18 6.84 $ 55,000 Options exercised (176,365 ) 2.72 Balance, September 30, 2019 1,585,082 $ 3.23 6.11 $ 61,460 Exercisable as of September 30, 2019 1,451,359 $ 3.05 5.96 $ 56,535 10Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)$515$307 as of SeptemberJune 30, 2019.2020. The weighted average period over which the total unrecognized compensation cost related to these unvested stock awards will be recognized is 1.130.66 years.The weighted average fair value of options granted during the nine months ended September 30, 2018 was $5.97 per share, or an aggregate grant date fair value of $806. There were no options granted during the nine months ended September 30, 2019.On January 2, 2018, the Compensation Committee of the Company’s Board of Directors granted, and the full Board ratified, an option to acquire an aggregate of 125,000 shares under the 2014 Plan to the Company’s CEO. This option vests 25% on the one-year anniversary of the grant date and monthly thereafter for 36 months, such that the option is vested in full on the four-year anniversary of the grant date. On January 2, 2018, the Company’s Compensation Committee granted, and the full Board ratified, options to each of the then-seated non-employee Directors to acquire 5,000 shares, for an aggregate of 10,000 shares, under the 2014 Plan. These options vest on the one-year anniversary of their grant date. On February 28, 2018, the Compensation Committee of the Company’s Board of Directors accelerated the vesting on stock options issued to consultants such that all unvested shares were vested on that date. This resulted in a one-time expense of $49 during the three months ended March 31, 2018.Determining the Fair Value of Stock OptionsThe Company uses the Black-Scholes pricing model to determine the fair value of stock options. The fair value of each option grant is estimated on the date of the grant. There were no stock options granted during the nine months ended September 30, 2019. There were no stock0 options granted during the three or six months ended SeptemberJune 30, 2018. There were 135,000 stock options granted during the nine months ended September 30, 2018. The following assumptions for the periods presented were: Three months ended
September 30, Nine months ended
September 30, 2019 2018 2019 2018 Expected term (in years) - - - 5 Risk-free interest rate - % - % - % 2.02 % Expected volatility - % - % - % 0.99 % Expected dividend rate - % - % - % - % The assumptions are based on the following for each of the periods presented:Valuation Method — The Company estimates the fair value of its stock options using the Black-Scholes option pricing model.Expected Term — The Company estimates the expected term consistent with the simplified method identified by the SEC. The Company elected to use the simplified method because of its limited history of stock option exercise activity and its stock options meet the criteria of the “plain-vanilla” options as defined by the SEC. The simplified method calculates the expected term as the average of the vesting and contractual terms of the award.Volatility — The Company derives this number from the historical stock volatilities of the Company’s stock over a period approximately equal to the expected term of the options.Risk-free Interest Rate — The risk-free interest rate is based on median U.S. Treasury zero coupon issues with remaining terms similar to the expected term on the options.Expected Dividend— The Company has never declared2020 or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and therefore, used an expected dividend yield of zero in the valuation model.Forfeiture — Beginning in the first quarter of 2017, the Company implemented ASU 2016-09, and elected to true-up calculations at the time of forfeiture, rather than creating an estimate at the time of option issuance.8661 and $139$98 as it relates to stock-based compensation for the three months ended SeptemberJune 30, 20192020 and 2018,2019, respectively. The Company has recorded an expense of $282$128 and $470 $196 as it relates to stock-based compensation for the ninesix months ended June 30, 2020 and 2019, respectively:20192019. The decrease in the effective tax rate for the three months ended June 30, 2020 is primarily related to tax benefit from discrete events that occurred during the quarter.2018, respectively:six months ended June 30, 2020, respectively, differed from the U.S. federal statutory rate of 21% primarily due to state income taxes (net of federal benefit) partially offset by tax benefits associated with employee equity plans, federal and state research and development (“R&D”) credit benefit and the effect of changes in enacted tax laws. The difference between the U.S. federal statutory rate of 21% and the Company’s effective tax rate for the three and six months ended June 30, 2019,11Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data) Three months ended
September 30, Nine months ended
September 30, 2019 2018 2019 2018 Cost of Revenue $ 1 $ 1 $ 1 $ 1 Engineering and Product Development 2 9 14 26 Sales and Marketing 7 23 39 74 General and Administrative 76 106 228 369 Total $ 86 $ 139 $ 282 $ 470 9. Three months ended September 30, 2019 2018 Shares Net Income EPS Shares Net Income EPS Basic EPS 6,492,501 $ 7,779 $ 1.20 6,086,489 $ 1,468 $ 0.24 Common stock warrants 155,490 - 354,420 - Common stock options 1,460,062 - 1,486,897 - Diluted EPS 8,108,053 $ 7,779 $ 0.96 7,927,788 $ 1,468 $ 0.19 Nine months ended September 30, 2019 2018 Shares Net Income EPS Shares Net Income EPS Basic EPS 6,410,588 $ 12,251 $ 1.91 5,998,460 $ 3,626 $ 0.60 Common stock warrants 190,144 - 308,529 - Common stock options 1,521,264 - 1,304,972 - Diluted EPS 8,121,996 $ 12,251 $ 1.51 7,611,961 $ 3,626 $ 0.48 ThereThe were no weighted average shares outstanding of common stock equivalents excluded from the computation of diluted net incomeloss per share for the three or ninesix months ended SeptemberJune 30, 20192020 and 2018. 2019.10.Income Tax BenefitThe Company’s income tax provision (benefit) for the three and nine months ended September 30, 2019 and September 30, 2018 reflects its estimate of the effective tax rates expected to be applicable for the full year, adjusted for any discrete events that are recorded in the period in which they occur. The estimates are re-evaluated each quarter based on the estimated tax expense for the full year. During the three months ended September 30, 2019, management determined there was sufficient positive evidence that it was more likely than not that the federal and state net operating loss (“NOL”) carryforwards and other related deferred tax assets would be realized and therefore, released the valuation allowance against the deferred tax assets.The Company recorded a tax benefit of approximately $4,671 and a tax provision of $0 for the three months ended September 30, 2019 and 2018, respectively. The Company recorded a tax benefit of approximately $4,594 and a tax provision of $0 for the nine months ended September 30, 2019 and 2018, respectively, representing effective tax rates of (60)% and 0%, respectively. The tax benefit during the three and nine months ended September 30, 2019 was primarily due to the release of valuation allowances of approximately $5,338.None12Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)The difference between the U.S. federal statutory tax rate of 21% and the Company’s effective tax rate of (60)% for the nine months ended September 30, 2019 is primarily due to the release of the allowance against the deferred tax assets referred to above. In addition, the currently expected annual tax rate takes into account actual year-to-date pre-tax and taxable income as well as expected activity through December 31, 2019. Expected activity for the fourth quarter 2019 does not include certain discrete transactions as deductions for stock options that might be exercised in the fourth quarter, and accordingly the year-end effective tax rate may differ from current expectations. The difference between the U.S. Federal statutory rate of 21% and the Company’s effective tax rate of 0% for the nine months ended September 30, 2018 was due primarily to NOL carryforwards that offset potential current taxes for which a full valuation allowance had been previously provided.2018,2019, and the information under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K filed with the SEC on March 7, 2019,9, 2020, or the Annual Report. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. See “Cautionary Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under “Risk Factors” in our Annual Report.Report and the ongoing COVID-19 pandemic.an emerging growtha company providing technology solutions to improve the clinical effectiveness and efficiency of healthcare providers. Our mission is to develop, manufacture and market innovative proprietary products and services that assist our customers in evaluating and treating chronic diseases. In 2011, we began commercializing our first patented and U.S. Food and Drug Administration, or FDA, cleared product, which measured arterial blood flow in the extremities to aid in the diagnosis of peripheral arterial disease, or PAD. In March 2015, we received FDA 510(k) clearance for the next generation version of our product, QuantaFlo™QuantaFlo®, which we began commercializing in August 2015. We believe our products and services position us to provide valuable information to our customer base, which in turn permits them to better guide patient care.SeptemberJune 30, 2019,2020, we had total revenues of $8,902,000$6,373,000 and net income of $7,779,000$1,075,000, compared to total revenues of $5,579,000$7,953,000 and net income of $1,468,000$2,619,000 in the same period in 2018.2019. In the ninesix months ended SeptemberJune 30, 2019,2020, we had total revenues of $23,616,000$15,803,000 and net income of $12,251,000$3,748,000 compared to total revenues of $15,526,000$14,714,000 and net income of $3,626,000$4,472,000 in the same period in 2018.2019.Emerging Growth Company ElectionsBecause we started to experience the effects of COVID-19 late in the first quarter, which continued into the second quarter, results in the second quarter are not indicative of any future quarter or the full fiscal year results. Overall, we have experienced decreased test volumes due to “social distancing” and other executive orders mandating “shelter-in-place” or similar restrictions, which limited patient visits by our customers. This volume decrease has primarily affected revenues from our variable-fee licenses, which are based on usage of our QuantaFlo® product, often during home visits by our customers.The JOBS Act providesNotably, as state and local governments eased restrictions during the second quarter, testing volumes increased, along with associated revenues. In June 2020 compared to May 2020, variable-fee license revenues increased to $249,000 from $19,000.an emerging growth company, suchour operating expenses will increase during the third quarter of 2020 as our company, can take advantage of an extended transition period for complying with new or revised accounting standards. This allows an emerging growth company to delay the adoption of these accounting standards until they would otherwise apply to private companies. We have elected to avail ourselves of this exemption. As a result our financial statements may not be comparable to other public companies that comply with public company effective dates. Inof new hiring. Until the future, we may elect to opt outeffects of the extended period for adopting new accounting standards. IfCOVID-19 pandemic on our business are more quantifiable, we do so, we would neednot plan to disclose such decision and it would be irrevocable. We expectundertake any material changes to cease being an emerging growth company asour business plan or operations.Factors Affecting Future ResultsWe have not identified any factors that have a recurring effect that are necessary to understand period to period comparisons as appropriate, nor any one-time events that have an effect on the financials.SeptemberJune 30, 20192020 Compared to Three Months Ended SeptemberJune 30, 20182019$8,902,000$6,373,000 for the three months ended SeptemberJune 30, 2019, an increase2020, a decrease of $3,323,000,$1,580,000, or 60%20%, compared to $5,579,000$7,953,000 in the same period in 2018.2019. Our revenues are primarily from fees charged to customers for use of our vascular testing products and from salessale of accessories used with these products. We recognized revenues of $8,612,000$6,244,000 from fees for our vascular testing products for the three months endedSeptemberJune 30, 20192020, an increasea decrease of $3,086,000$1,403,000 compared to $5,526,000$7,647,000 in the same period of the prior year. Of these fees,The primary reason for the decrease is decreased testing volumes due to the ongoing COVID-19 pandemic, which significantly reduced revenues from variable-fee licenses. Fixed-fee license revenues were approximately $5,951,000$5,954,000, a decrease of $557,000, or 10%, variable-fee license revenues were from fixed price software license fees, and approximately $2,660,000 from variable price software license fees.$290,000. The remainder of our revenues was from other items, such as the sale of equipment, supplies or accessories sales, which were $291,000$129,000 in the three months endedSeptemberJune 30, 20192020, as compared to $53,000$306,000 in the same period of the prior year.and primarily represent licensing fees for software, which are usually billed as a fixed monthly feefixed-fee or as a variable usage-based monthly fee. The primary reason for the increase in revenues was growth in the number of installed units from both new customers and established customers, which we believe is the result of our sales and marketing efforts.variable-fee dependent on usage14$5,791,000$5,413,000 for the three months ended SeptemberJune 30, 2019,2020, an increase of $1,758,000,$155,000 or 44%3%, compared to $4,033,000$5,258,000 in the same period ofin the prior year. The primary reason for this change was increased compensationheadcount of thefield sales team, as well as an increase in our field sales,and technical support personnel, headcountwhich offset decreases in cost of revenues and administrationgeneral and administrative expenses. As a percentage of revenues, operating expenses increased to service our expanding number85% in the second quarter of customers.2020 as compared to 66% in the prior year period. The changes in the various components of our operating expenses are described below.$974,000$700,000 for the three months ended SeptemberJune 30, 2019, an increase2020, a decrease of $359,000,$185,000, or 58%21%, compared to $615,000$885,000 in the same period of the prior year.The primary reason for this change was increased costs due to increased sales volume of, placement ofdecreased headcount and technical support for installations in the field. These increases were partially offset by lower depreciation per unit per month as a greater percentage of installations were software and sensor only rather than laptop, software and sensor, as well as lower residual value for retired units.sensor. As a percentage of revenues, cost of revenues was 11% forin both periods.$617,000$762,000 for the three months ended SeptemberJune 30, 2019,2020, an increase of $30,000,$171,000, or 5%29%, compared to $587,000$591,000 in the same period of the prior year. The increase was primarily due to increased personnel and other costs associated with our product development and customization efforts, partially offset by lower consultant costs. As a percentage of revenues, engineering and product development expense increased to 12% in the second quarter of 2020, as compared to 7% in the prior year period.we continued workthe sale of equipment, supplies or accessories sales, which were $400,000 in the six months ended June 30, 2020, as compared to $552,000 in the same period of the prior year.ongoingusage.efforts.efforts. As a percentage of revenues, engineering and product development expense increased to 10% in the first half of 2020, as compared to 8% in the prior year period.$2,345,000$5,168,000 for the threesix months ended SeptemberJune 30, 2019,2020, an increase of $547,000,$887,000, or 30%21%, compared to $1,798,000$4,281,000 in the same period of the prior year. The increase was primarily due to higher sales compensation and personnel expense as well as increased headcount and expense, each associated with the continued expansion of existing customers, education, training, and associated expense, partially offset by lower travel expenses. As a growing business.percentage of revenues, sales and marketing expense increased to 33% in the first half of 2020, as compared to 29% in the prior year period.$1,855,000$3,069,000 for the threesix months ended SeptemberJune 30, 2019,2020, an increase of $822,000,$126,000, or 80%4%, compared to $1,033,000$2,943,000 in the same period of the prior year. The increase was primarily due to the growth in our business, which led to increased expenses to support a growing company, including higher infrastructure costs, insurance and other professional fees, as well as higher compensation and personnel expense.Other expenseWe had other expense of $3,000 for the three months ended September 30, 2019, a decrease of $75,000, or 96%, compared to other expense of $78,000 in the same period of the prior year. The decrease was primarily due to a decrease in interest expense of $73,000 associated with retirement of notes payable.Income tax benefitWe had an income tax benefit of $4,671,000 for the three months ended September 30, 2019, which included current tax expense of $38,000 related to the period, offset by a $4,709,000 benefit relating to the release of the entire allowance against deferred tax assets. The remaining valuation allowance was released due to our recent history of eight straight quarters of positive income before income taxes, resulting in a credit to income tax expense. Due to full release of the valuation allowance, income in future periods may also result in tax expense.Net incomeFor the foregoing reasons, we had net income of $7,779,000, or $1.20 per basic share and $0.96 per diluted share, for the three months ended September 30, 2019, an increase of $6,311,000, or 430%, compared to a net income of $1,468,000, or $0.24 per basic share and $0.19 per diluted share, for the same period of the prior year. We had income before income taxes of $3,108,000 for the three months ended September 30, 2019, an increase of $1,640,000, or 112%, compared to income before income taxes of $1,468,000 for the same period of the prior year.15Nine Months Ended September 30, 2019 Compared to Nine Months Ended September 30, 2018RevenuesWe had revenues of $23,616,000 for the nine months ended September 30, 2019, an increase of $8,090,000, or 52%, compared to $15,526,000 in the same period in 2018.Our revenues are primarily from fees charged to customers for use of our vascular testing products and from sales of accessories used with these products. We recognized revenues of $22,774,000 from fees for our vascular testing products for the nine months endedSeptember 30, 2019, an increase of $7,522,000 compared to $15,252,000 in the same period of the prior year. Of these fees, approximately $16,608,000 were from fixed price software license fees, and approximately $6,166,000 from variable price software license fees. The remainder was from other items, such as the sale of equipment, supplies or accessories sales, which were $842,000 in the nine months endedSeptember 30, 2019, as compared to $274,000 in the same period of the prior year.Revenues from fees for vascular testing products are recognized monthly for each unit installed with a customer, and primarily represent licensing fees for software, which are usually billed as a fixed monthly fee or as a variable usage-based monthly fee. The primary reason for the increase in revenues was growth in the number of installed units from both new customers and established customers, which we believe is the result of our sales and marketing efforts.Operating expensesWe had total operating expenses of $15,956,000 for the nine months ended September 30, 2019, an increase of $4,323,000, or 37%, compared to $11,633,000 in the same period in the prior year. The primary reason for this change was overall growth in our business, which led to increased compensation of the sales team, as well as an increase in our field sales, technical support personnel headcount and administration expenses to service the expanding number of customers. The changes in the various components of our operating expenses are described below.Cost of revenuesWe had cost of revenues of $2,755,000 for the nine months ended September 30, 2019, an increase of $756,000, or 38%, compared to $1,999,000 in the same period of the prior year.The primary reason for this change was increased costs due to increased sales volume of, placement of and technical support for installations in the field. These increases were partially offset by lower depreciation per unit per month as a greater percentage of installations were software and sensor only rather than laptop, software and sensor, as well as lower residual value for retired units.As a percentage of revenues, cost of revenuesgeneral and administrative expense decreased to 12%,19% in the first half of 2020, as compared to 13%, primarily due to revenue growing at a faster pace than cost of revenue.20% in the prior year period.Engineering and product development expenseengineering and product development expenseother income of $1,777,000$29,000 for the ninesix months ended SeptemberJune 30, 2019, an increase of $334,000, or 23%,2020, compared to $1,443,000 in the same period of the prior year.The increase was primarily due to consultant costs, personnel andno other costs associated with ongoing projects related to our product development and customization efforts, including new applications for our product as well as other product enhancements.Sales and marketing expenseWe had sales and marketing expense of $6,626,000 for the nine months ended September 30, 2019, an increase of $1,343,000, or 25%, compared to $5,283,000income in the same period of the prior year. The increase was primarily due to higher sales compensationmiscellaneous income and personnelinterest income, partially offset by credit card merchant fees. as well as increased headcount and expense, each associated with a growing business.General and administrative expensegeneral and administrativeincome tax expense of $4,798,000$692,000 for the ninesix months ended SeptemberJune 30, 2019, an increase of $1,890,000, or 65%,2020, compared to $2,908,000$77,000 income tax expense in the same period of the prior year. The increase was primarily due to the growth inamortization of our business, which led to increased expenses to support a growing company, including higher infrastructure costs, insurance and other professional fees, as well as higher compensation and personnel expense.16Other expenseWe had other expense of $3,000 for the nine months ended September 30, 2019, a decrease of $264,000, or 99%, compared to $267,000 in the same period of the prior year. The decrease was primarily due to a decrease in interest expense of $263,000 associated with retirement of notes payable.Income tax benefitWe had an income tax benefit of $4,594,000 for the nine months ended September 30, 2019, which included current tax expense of $115,000 related to the year-to-date operations, offset by a $4,709,000 benefit relating to the release of the entire allowance against deferred tax assets. The remaining allowance was released due to our recent history of eight straight quarters of positive income before income taxes, resulting in a credit to income tax expense. Due to full release of the valuation allowance, income in future periods may also result in tax expense.asset.$12,251,000,$3,748,000, or $1.91$0.57 per basic share and $1.51$0.47 per diluted share, for the ninesix months ended SeptemberJune 30, 2019, an increase2020, a decrease of $8,625,000,$724,000, or 238%16%, compared to a net income of $3,626,000,$4,472,000, or $0.60$0.70 per basic share and $0.48$0.55 per diluted share, for the same period of the prior year. We had income before income taxes$8,542,000$13,646,000 at SeptemberJune 30, 20192020 compared to $3,284,000$7,741,000 at December 31, 2018,2019, and total current liabilities of $4,747,000$4,368,000 at SeptemberJune 30, 20192020 compared to $3,512,000$5,207,000 at December 31, 2018.2019. As of SeptemberJune 30, 2019,2020, we had working capital of approximately $7,340,000. $10,899,000.$9,093,000$6,082,000 of net cash from operating activitiesfor the ninesix months ended SeptemberJune 30, 20192020 compared to generating $2,651,000$4,383,000 of net cash infrom operating activities for the same period of the prior year. The improvement was primarily due to changes in net income, as well as both non-cash adjustments and changes in our operating assets and liabilities, which occurred due to growth in our business, and affectedmore than offset the decrease in net income. Non-cash adjustments to reconcile net income to net cash from operating activities were $1,120,000 and were primarily due to deferred tax expense of $596,000, depreciation accruedof assets for lease of $172,000, stock-based compensation expense of $128,000, loss on disposal of assets for lease of $125,000, fixed assets depreciation and amortization of $63,000 and allowance for bad debt expense of $36,000. Changes in operating assets and liabilities provided $1,214,000 of net cash, primarily due to trade accounts receivable of $2,468,000, which were partially offset by cash used by accrued expenses of $573,000, prepaid expenses of $408,000, deferred revenue of $142,000, and accounts payable deferred revenue and trade accounts receivable.of $131,000.$1,208,000$247,000 of net cash in investing activities for the ninesix months ended SeptemberJune 30, 2020, which reflects purchases of assets for lease of $147,000 and fixed asset purchases of $100,000 to support our growing business.$1,102,000$779,000 and fixed asset purchases of $106,000$63,000 to support our growing business.$453,000 of net cash$2,643,000 in investing activities for the nine months ended September 30, 2018, which reflects purchases of assets for lease of $323,000 and fixed asset purchases of $131,000 to support our growing business.Financing activitiesWe used $2,627,000 of net cash in financing activities during the ninesix months ended SeptemberJune 30, 2019, primarily due to the repurchasere-purchase of warrants of $2,687,000 from our chief executive officer in May 2019, partially offset by proceeds from the exercise of stock options of $60,000.$44,000.We used $568,000 of net cash in financing activities during the nine months ended September 30, 2018, reflecting the payment of loans payable of $1,072,000, partially offset by proceeds from the exercise of warrants and stock options of $504,000.SeptemberJune 30, 20192020 and December 31, 2018,2019, we had no off-balance sheet arrangements.17SeptemberJune 30, 20192020 and December 31, 2018,2019, other than employment/consulting agreements with key executive officers and our facilities lease obligation, we had no material commitments other than the liabilities reflected in our financial statements.management recognizeswe recognized that any controls and procedures,a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of achieving the desired control objectives,system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and management isinstances of fraud, if any, within a company have been detected. Management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our management,chief executive officer,management, including our senior vice president, financeChief Executive Officer, our Senior Vice President, Finance and accountingAccounting and our vice president, finance,Vice President, Finance, we evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of June 30, 2020. Based upon that evaluation, our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance concluded that, because of the material weaknesses in our internal control over financial reporting, our disclosure controls and procedures were not effective. Notwithstanding the material weaknesses, our management, including our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance, has concluded that the consolidated financial statements included in this Quarterly Report on Form 10-Q are fairly stated, in all material respects, in accordance with generally accepting accounting principles in the United States for each of the periods presented herein.endyear ended December 31, 2019:a. Insufficient segregation of duties, oversight of work performed and ineffective compensating controls in our finance and accounting functions due to limited personnel; b. Our information technology general controls related to user access security and change management controls related to our enterprise resource planning system were not designed effectively to provide an adequate audit trail for system change management controls and for the periodic review and testing of user access rights and permissions. c. We did not sufficiently design and effectively implement controls to validate the completeness and accuracy of underlying data used in the performance of various controls over accounting transactions and disclosures; d. We did not design sufficient protocols and procedures to retain adequate documentary evidence related to the timely review and approval of manual journal entries including the review of the underlying information at a sufficient level of detail; and e. We did not sufficiently design and retain adequate documentary evidence supporting the design and operating effectiveness of certain important management review controls including the precision of review and evidence of procedures performed. period covered by this quarterly reportmaterial weaknesses described above, combined with ineffective compensating financial close and review controls, had a pervasive impact on Form 10-Q. Basedour activity level cycles and accounts and creates a reasonable possibility that a material misstatement of the consolidated financial statements will not be prevented or detected on that evaluation,a timely basis. Although we have continued to implement our chief executive officer, our senior vice president, finance and accounting, and our vice president, financeremediation plan, these material weaknesses persist. Accordingly, management concluded that our disclosure controls and procedures were not effective at the reasonable assurance level, as of the end of the period covered by this report to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (1) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) is accumulated and communicated to management, including our chief executive officer, senior vice president, finance and accounting, and our vice president, finance as appropriate to allow timely decisions regarding required disclosure, due to the existence of a material weakness in our internal control over financial reporting.June 30, 2020.ThereIn an effort to remediate our prior material weaknesses, in the second quarter of 2020, we implemented additional procedures to segregate duties over the initiation of transactions, the recording of transactions, and the custody of assets and improved documentation for payroll approvals and review. Other than these remedial changes, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during our thirdsecond fiscal quarter ended SeptemberJune 30, 2019.2020.1817Not applicable.Exh. No.1918November2019 2020 20