UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the quarterly period ended SeptemberJune 30, 20172019
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: 1-33818
RESHAPE LIFESCIENCES INC.INC.
(Exact name of registrant as specified in its charter)
Delaware | 48-1293684 |
(State or other jurisdiction | (IRS Employer |
2800 Patton Road, St. Paul, Minnesota 551131001 Calle Amanecer, San Clemente, California 92673
(Address of principal executive offices, including zip code)
(651) 634-3003(949) 429-6680
(Registrant’s telephone number, including area code)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically, and posted on its corporate Website, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting 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.
Large accelerated filer | ☐ | Accelerated Filer | ☐ |
Non-accelerated filer |
| Smaller Reporting Company | ☒ |
Emerging Growth Company | ☐ |
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If an emerging growth company, indicate by check mark whether the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒
Securities registered pursuant to Section 12(b) of the Act:
Title of Class | Trading Symbol | Name of Exchange on which Registered | |
Common stock, $0.01 par value per share | RSLS | OTCQB Market |
As of October 31, 2017, 21,718,713August 12, 2019, 30,605,233 shares of the registrant’s Common Stock were outstanding.
Registered Trademarks and Trademark Applications: In the United States we have registered trademarks for vBLOC®, ENTEROMEDICS®, MAESTRO®, RESHAPE®, RESHAPE DUO®, and RESHAPE MEDICAL®, each registered with the United States Patent and Trademark Office, and trademark applications for vBLOC POWER TO CHOOSE and VBLOC POWER TO CHOOSE AND DESIGN. In addition, some or all of the marks vBLOC, ENTEROMEDICS, MAESTRO, MAESTRO SYSTEM ORCHESTRATING OBESITY SOLUTIONS, vBLOC POWER TO CHOOSE, vBLOC POWER TO CHOOSE AND DESIGN RESHAPE, RESHAPE DUO, RESHAPE MEDICAL and RESHAPE LIFESCIENCES are the subject of either a trademark registration or application for registration in Australia, Brazil, Canada, China, the European Community, India, Kuwait, Mexico, Saudi Arabia, Switzerland and the United Arab Emirates. We believe that we have common law trademark rights to GASTRIC VEST. This Quarterly Report on Form 10-Q contains other trade names and trademarks and service marks of ReShape Lifesciences and of other companies.
2
PART I – FINANCIAL INFORMATION
ITEM 1. CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
RESHAPE LIFESCIENCES INC.
Condensed Consolidated Balance Sheets
(Unaudited)(dollars in thousands, except per share amounts; unaudited)
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| September 30, |
| December 31, |
| June 30, |
| December 31, | ||||
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| 2017 |
| 2016 |
| 2019 |
| 2018 | ||||
ASSETS |
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Current assets: |
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Cash and cash equivalents |
| $ | 23,433,297 |
| $ | 3,310,787 |
| $ | 4,355 |
| $ | 5,548 |
Accounts receivable (net of allowance for bad debts of $20,000 at September 30, 2017 and December 31, 2016) |
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| 333,057 |
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| 143,692 | ||||||
Inventory |
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| 1,586,629 |
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| 1,789,578 | ||||||
Prepaid expenses and other current assets |
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| 252,473 |
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| 476,624 | ||||||
Accounts and other receivables (net of allowance for bad debts of $387 at June 30, 2019 and $236 at December 31, 2018) (Note 4) |
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| 4,625 |
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| 917 | ||||||
Finished goods inventory |
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| 1,348 |
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| 985 | ||||||
Prepaid expenses and other current assets (Note 4) |
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| 2,303 |
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| 1,269 | ||||||
Total current assets |
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| 25,605,456 |
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| 5,720,681 |
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| 12,631 |
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| 8,719 |
Property and equipment, net |
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| 195,514 |
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| 200,720 |
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| 27 |
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| 64 |
Goodwill |
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| 6,397,671 |
|
| — | ||||||
Other intangible assets (net of accumulated amortization of $44,777 at September 30, 2017) |
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| 21,842,409 |
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| — | ||||||
Operating lease right-of-use assets (Note 7) |
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| 963 |
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| — | ||||||
Other intangible assets, net (Note 5) |
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| 29,506 |
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| 36,927 | ||||||
Other assets |
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| 1,142,304 |
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| 1,119,405 |
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| 563 |
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| 563 |
Total assets |
| $ | 55,183,354 |
| $ | 7,040,806 |
| $ | 43,690 |
| $ | 46,273 |
LIABILITIES AND STOCKHOLDERS’ EQUITY |
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Current liabilities: |
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Accounts payable |
| $ | 706,520 |
| $ | 1,311,706 | ||||||
Accrued expenses |
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| 3,427,245 |
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| 2,751,415 | ||||||
Accounts payable and accrued liabilities (Note 4) |
| $ | 9,853 |
| $ | 6,456 | ||||||
Asset purchase consideration payable, current (Note 6) |
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| 1,955 |
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| 1,907 | ||||||
Operating lease liabilities, current (Note 7) |
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| 343 |
|
| — | ||||||
Total current liabilities |
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| 4,133,765 |
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| 4,063,121 |
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| 12,151 |
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| 8,363 |
Common stock warrant liability |
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| 2,159 |
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| 39,119 | ||||||
Asset purchase consideration payable, noncurrent (Note 6) |
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| 4,520 |
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| 4,403 | ||||||
Operating lease liabilities, noncurrent (Note 7) |
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| 626 |
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| — | ||||||
Deferred income taxes |
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| 1,258 |
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| 1,844 | ||||||
Common stock warrant liability (Note 8) |
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| 11,743 |
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| — | ||||||
Total liabilities |
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| 4,135,924 |
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| 4,102,240 |
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| 30,298 |
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| 14,610 |
Commitments and contingencies (Note 5) |
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Commitments and contingencies (Note 13) |
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Stockholders’ equity: |
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Preferred stock, 5,000,000 shares authorized: |
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Series A convertible preferred stock, $0.01 par value; zero shares outstanding at September 30, 2017 and December 31, 2016; 12,531 and zero shares issued at September 30, 2017 and December 31, 2016, respectively |
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| — |
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| — | ||||||
Conditional convertible preferred stock, $0.01 par value; 1,000,181 and zero shares issued and outstanding at September 30, 2017 and December 31, 2016 |
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| 10,002 |
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| — | ||||||
Series B convertible preferred stock, $0.01 par value; 20,000 shares issued and 11,003 and zero shares outstanding at September 30, 2017 and December 31, 2016 |
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| 110 |
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Common stock, $0.01 par value; 300,000,000 shares authorized; 12,208,671 and 2,736,621 shares issued and outstanding at September 30, 2017 and December 31, 2016, respectively |
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| 122,087 |
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| 27,366 | ||||||
Series B convertible preferred stock, $0.01 par value; 3 and 159 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively |
|
| — |
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| — | ||||||
Series C convertible preferred stock, $0.01 par value; 95,388 shares issued and outstanding at June 30, 2019 and December 31, 2018 |
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| 1 |
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| 1 | ||||||
Common stock, $0.01 par value; 275,000,000 shares authorized at June 30, 2019 and December 31, 2018; 28,505,233 and 8,770,433 shares issued and outstanding at June 30, 2019 and December 31, 2018, respectively |
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| 285 |
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| 88 | ||||||
Additional paid-in capital |
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| 376,057,278 |
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| 303,852,582 |
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| 452,492 |
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| 450,564 |
Accumulated deficit |
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| (325,142,047) |
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| (300,941,382) |
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| (439,386) |
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| (418,990) |
Total stockholders’ equity |
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| 51,047,430 |
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| 2,938,566 |
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| 13,392 |
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| 31,663 |
Total liabilities and stockholders’ equity |
| $ | 55,183,354 |
| $ | 7,040,806 |
| $ | 43,690 |
| $ | 46,273 |
See accompanying notes to condensed consolidated financial statements.
Condensed Consolidated Financial Statements.
3
RESHAPE LIFESCIENCES INC.
Condensed Consolidated Statements of Operations
(Unaudited)(dollars in thousands, except per share amounts; unaudited)
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| Three Months Ended September 30, |
| Nine Months Ended September 30, |
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| Three Months Ended June 30, |
| Six Months Ended June 30, |
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| 2017 |
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| 2016 |
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| 2017 |
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| 2016 |
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| 2019 |
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| 2018 |
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| 2019 |
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| 2018 |
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Sales revenue |
| $ | 110,020 |
| $ | 296,760 |
| $ | 243,120 |
| $ | 644,760 |
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Service revenue |
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| 250,000 |
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| — |
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| 250,000 |
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| — |
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Total revenue |
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| 360,020 |
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| 296,760 |
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| 493,120 |
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| 644,760 |
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Revenue |
| $ | 4,450 |
| $ | 10 |
| $ | 7,524 |
| $ | 149 |
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Cost of revenue |
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| 214,511 |
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| 146,631 |
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| 298,506 |
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| 342,070 |
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| 1,593 |
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| 3 |
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| 2,436 |
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| 63 |
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Gross profit |
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| 145,509 |
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| 150,129 |
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| 194,614 |
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| 302,690 |
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| 2,857 |
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| 7 |
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| 5,088 |
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| 86 |
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Operating expenses: |
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Selling, general and administrative |
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| 4,595,538 |
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| 3,361,572 |
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| 16,085,311 |
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| 15,088,297 |
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| 6,792 |
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| 4,327 |
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| 12,213 |
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| 10,663 |
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Research and development |
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| 1,109,641 |
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| 1,253,390 |
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| 3,586,129 |
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| 3,879,378 |
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| 960 |
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| 2,053 |
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| 2,016 |
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| 4,553 |
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Impairment of intangible assets (Note 5) |
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| 6,588 |
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| 14,005 |
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| 6,588 |
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| 14,005 |
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Total operating expenses |
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| 5,705,179 |
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| 4,614,962 |
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| 19,671,440 |
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| 18,967,675 |
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| 14,340 |
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| 20,385 |
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| 20,817 |
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| 29,221 |
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Operating loss |
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| (5,559,670) |
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| (4,464,833) |
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| (19,476,826) |
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| (18,664,985) |
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|
| (11,483) |
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| (20,378) |
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| (15,729) |
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| (29,135) |
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Other income (expense): |
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Interest income |
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| — |
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| 1,493 |
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| 100 |
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| 4,991 |
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Interest expense |
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| — |
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| (1,391,134) |
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| — |
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| (3,393,374) |
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Warrants expense |
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| (4,438,149) |
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| — |
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| (4,438,149) |
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| — |
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Change in value of warrant liability |
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| 5,047 |
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| 241,741 |
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| (283,688) |
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| 3,330,254 |
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Change in value of convertible notes payable |
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| — |
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| (909,030) |
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| — |
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| (200,004) |
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Other expense (income), net: |
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Interest expense, net |
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| 213 |
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| 1 |
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| 316 |
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| 2 |
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Loss on extinguishment of debt (Note 6) |
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| 71 |
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| — |
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| 71 |
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| — |
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Warrant expense (Note 8) |
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| 4,127 |
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| 145 |
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| 4,257 |
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| 145 |
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Other, net |
|
| (904) |
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| (700) |
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| (2,102) |
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| (3,272) |
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| 612 |
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| (3) |
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| 609 |
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| (2) |
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Loss from continuing operations before income taxes |
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| (16,506) |
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| (20,521) |
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| (20,982) |
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| (29,280) |
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Income tax benefit |
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| 586 |
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| 1,209 |
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| 586 |
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| 2,591 |
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Loss from continuing operations |
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| (15,920) |
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| (19,312) |
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| (20,396) |
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| (26,689) |
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Loss from discontinued operations, net of tax |
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| — |
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| (15,939) |
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| — |
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| (19,795) |
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Net loss |
| $ | (9,993,676) |
| $ | (6,522,463) |
| $ | (24,200,665) |
| $ | (18,926,390) |
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| $ | (15,920) |
| $ | (35,251) |
| $ | (20,396) |
| $ | (46,484) |
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Net loss per share—basic and diluted |
| $ | (1.06) |
| $ | (11.77) |
| $ | (3.19) |
| $ | (69.14) |
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Less: Down round adjustments for convertible preferred stock and warrants |
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| — |
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| (3,842) |
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| — |
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| (3,842) |
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Net loss attributable to common shareholders |
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| (15,920) |
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| (39,093) |
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| (20,396) |
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| (50,326) |
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Net loss per share - basic and diluted: |
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Continuing operations |
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| (1.25) |
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| (1,307.98) |
| $ | (1.94) |
| $ | (1,881.15) |
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Discontinued operations |
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| — |
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| (900.41) |
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| — |
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| (1,219.65) |
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Net loss per share - basic and diluted |
| $ | (1.25) |
| $ | (2,208.39) |
| $ | (1.94) |
| $ | (3,100.80) |
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Shares used to compute basic and diluted net loss per share |
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| 9,470,807 |
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| 554,028 |
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| 7,589,239 |
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| 273,751 |
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| 12,715,277 |
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| 17,702 |
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| 10,491,220 |
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| 16,230 |
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See accompanying notes to condensed consolidated financial statements.Condensed Consolidated Financial Statements.
4
RESHAPE LIFESCIENCES INC.
Condensed Consolidated Statements of Stockholders’ Equity
(dollars in thousands; unaudited)
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| Three Months Ended June 30, 2019 | |||||||||||||||||||||||||||
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| Series B Convertible |
| Series C Convertible |
| Series E Convertible |
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| Additional |
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| Total | ||||||||||||||
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| Preferred Stock |
| Preferred Stock |
| Preferred Stock |
| Common Stock |
| Paid-in |
| Accumulated |
| Stockholders’ | |||||||||||||||
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| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Deficit |
| Equity | |||||||
Balance March 31, 2019 |
| 3 |
| $ | — |
| 95,388 |
| $ | 1 |
| 1,192,000 |
| $ | 12 |
| 7,703,233 |
| $ | 77 |
| $ | 451,949 |
| $ | (423,466) |
| $ | 28,573 |
Net loss |
| — |
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| — |
| — |
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| — |
| — |
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| — |
| — |
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| — |
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| — |
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| (15,920) |
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| (15,920) |
Stock-based compensation expense |
| — |
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| — |
| — |
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| — |
| — |
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| — |
| — |
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| — |
|
| 728 |
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| — |
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| 728 |
Down round adjustments for convertible preferred stock and warrants |
| — |
|
| — |
| — |
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| — |
| — |
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| — |
| — |
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| — |
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| — |
|
| — |
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| — |
Institutional sales of common stock and warrants, net of issuance costs |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 15,600,000 |
|
| 156 |
|
| 127 |
|
| — |
|
| 283 |
Warrant adjustment |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| (312) |
|
| — |
|
| (312) |
Conversion of convertible preferred stock into common stock |
| — |
|
| — |
| — |
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| — |
| (1,192,000) |
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| (12) |
| 1,192,000 |
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| 12 |
|
| — |
|
| — |
|
| — |
Issuance of common stock upon exercise of warrants |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 4,010,000 |
|
| 40 |
|
| — |
|
| — |
|
| 40 |
Balance June 30, 2019 |
| 3 |
| $ | — |
| 95,388 |
| $ | 1 |
| — |
| $ | — |
| 28,505,233 |
| $ | 285 |
| $ | 452,492 |
| $ | (439,386) |
| $ | 13,392 |
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| Six Months Ended June 30, 2019 | |||||||||||||||||||||||||||
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| Series B Convertible |
| Series C Convertible |
| Series E Convertible |
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| Additional |
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| Total | ||||||||||||||
|
| Preferred Stock |
| Preferred Stock |
| Preferred Stock |
| Common Stock |
| Paid-in |
| Accumulated |
| Stockholders’ | |||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Deficit |
| Equity | |||||||
Balance December 31, 2018 |
| 159 |
| $ | — |
| 95,388 |
| $ | 1 |
| — |
| $ | — |
| 8,770,433 |
| $ | 88 |
| $ | 450,564 |
| $ | (418,990) |
| $ | 31,663 |
Net loss |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| — |
|
| (20,396) |
|
| (20,396) |
Stock-based compensation expense |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| 1,984 |
|
| — |
|
| 1,984 |
Warrant expense |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| 130 |
|
| — |
|
| 130 |
Down round adjustments for convertible preferred stock and warrants |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| — |
|
| — |
|
| — |
Institutional sales of common stock and warrants, net of issuance and other costs |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 15,600,000 |
|
| 156 |
|
| 127 |
|
| — |
|
| 283 |
Warrant adjustment |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| (312) |
|
| — |
|
| (312) |
Conversion of common stock into convertible preferred stock |
| — |
|
| — |
| — |
|
| — |
| 1,192,000 |
|
| 12 |
| (1,192,000) |
|
| (12) |
|
| — |
|
| — |
|
| — |
Conversion of convertible preferred stock into common stock |
| (156) |
|
| — |
| — |
|
| — |
| (1,192,000) |
|
| (12) |
| 1,316,800 |
|
| 13 |
|
| (1) |
|
| — |
|
| — |
Issuance of common stock upon exercise of warrants, net of transaction costs |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 4,010,000 |
|
| 40 |
|
| — |
|
| — |
|
| 40 |
Balance June 30, 2019 |
| 3 |
| $ | — |
| 95,388 |
| $ | 1 |
| — |
| $ | — |
| 28,505,233 |
| $ | 285 |
| $ | 452,492 |
| $ | (439,386) |
| $ | 13,392 |
See accompanying notes to Condensed Consolidated Financial Statements.
5
RESHAPE LIFESCIENCES INC.
Condensed Consolidated Statements of Stockholders’ Equity (Continued)
(dollars in thousands; unaudited)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Three Months Ended June 30, 2018 | |||||||||||||||||||||||||||
|
| Series B Convertible |
| Series C Convertible |
| Series D Convertible |
|
|
| Additional |
|
|
|
| Total | ||||||||||||||
|
| Preferred Stock |
| Preferred Stock |
| Preferred Stock |
| Common Stock |
| Paid-in |
| Accumulated |
| Stockholders’ | |||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Deficit |
| Equity | |||||||
Balance March 31, 2018 |
| 6,055 |
|
| — |
| 95,388 |
|
| 1 |
| — |
|
| — |
| 14,742 |
|
| — |
|
| 411,865 |
|
| (345,992) |
|
| 65,874 |
Net loss |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| — |
|
| (35,251) |
|
| (35,251) |
Stock-based compensation expense |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| 810 |
|
| — |
|
| 810 |
Down round adjustments for convertible preferred stock and warrants |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| 3,842 |
|
| (3,842) |
|
| — |
Institutional sale of convertible preferred stock and warrants in April 2018, net of issuance costs |
| — |
|
| — |
| — |
|
| — |
| 6,000 |
|
| — |
| — |
|
| — |
|
| 5,081 |
|
| — |
|
| 5,081 |
Institutional sales of common stock and warrants, net of issuance costs |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 6,030 |
|
| — |
|
| 2,501 |
|
| — |
|
| 2,501 |
Redemption of convertible preferred stock |
| — |
|
| — |
| — |
|
| — |
| (500) |
|
| — |
| — |
|
| — |
|
| (500) |
|
| — |
|
| (500) |
Conversions of convertible preferred stock into common stock |
| (3,098) |
|
| — |
| — |
|
| — |
| (750) |
|
| — |
| 4,267 |
|
| — |
|
| — |
|
| — |
|
| — |
Issuance of common stock upon exercise of warrants, net of transaction costs |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 750 |
|
| — |
|
| 595 |
|
| — |
|
| 595 |
Balance June 30, 2018 |
| 2,957 |
| $ | — |
| 95,388 |
| $ | 1 |
| 4,750 |
| $ | — |
| 25,789 |
| $ | — |
| $ | 424,194 |
| $ | (385,085) |
| $ | 39,110 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Six Months Ended June 30, 2018 | |||||||||||||||||||||||||||
|
| Series B Convertible |
| Series C Convertible |
| Series D Convertible |
|
|
| Additional |
|
|
|
| Total | ||||||||||||||
|
| Preferred Stock |
| Preferred Stock |
| Preferred Stock |
| Common Stock |
| Paid-in |
| Accumulated |
| Stockholders’ | |||||||||||||||
|
| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Shares |
| Amount |
| Capital |
| Deficit |
| Equity | |||||||
Balance December 31, 2017 |
| 6,055 |
| $ | — |
| 95,388 |
| $ | 1 |
| — |
| $ | — |
| 14,742 |
| $ | — |
| $ | 411,125 |
| $ | (334,759) |
| $ | 76,367 |
Net loss |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| — |
|
| (46,484) |
|
| (46,484) |
Stock-based compensation expense |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| 1,550 |
|
| — |
|
| 1,550 |
Down round adjustments for convertible preferred stock and warrants |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
|
| 3,842 |
|
| (3,842) |
|
| — |
Institutional sale of convertible preferred stock and warrants in April 2018, net of issuance costs |
| — |
|
| — |
| — |
|
| — |
| 6,000 |
|
| — |
| — |
|
| — |
|
| 5,081 |
|
| — |
|
| 5,081 |
Institutional sales of common stock and warrants, net of issuance costs |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 6,030 |
|
| — |
|
| 2,501 |
|
| — |
|
| 2,501 |
Redemption of convertible preferred stock |
| — |
|
| — |
| — |
|
| — |
| (500) |
|
| — |
| — |
|
| — |
|
| (500) |
|
| — |
|
| (500) |
Conversions of convertible preferred stock into common stock |
| (3,098) |
|
| — |
| — |
|
| — |
| (750) |
|
| — |
| 4,267 |
|
| — |
|
| — |
|
| — |
|
| — |
Issuance of common stock upon exercise of warrants, net of transaction costs |
| — |
|
| — |
| — |
|
| — |
| — |
|
| — |
| 750 |
|
| — |
|
| 595 |
|
| — |
|
| 595 |
Balance June 30, 2018 |
| 2,957 |
| $ | — |
| 95,388 |
| $ | 1 |
| 4,750 |
| $ | — |
| 25,789 |
| $ | — |
| $ | 424,194 |
| $ | (385,085) |
| $ | 39,110 |
See accompanying Notes to Condensed Consolidated Financial Statements.
6
RESHAPE LIFESCIENCES INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited)(dollars in thousands; unaudited)
|
|
|
|
|
|
|
|
|
| Nine Months Ended September 30, |
| ||||
|
| 2017 |
| 2016 |
| ||
Cash flows from operating activities: |
|
|
|
|
|
|
|
Net loss |
| $ | (24,200,665) |
| $ | (18,926,390) |
|
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
Depreciation |
|
| 113,831 |
|
| 109,382 |
|
Stock-based compensation |
|
| 3,483,451 |
|
| 2,201,949 |
|
Warrants issued to former holders of convertible notes |
|
| 4,438,149 |
|
| — |
|
Amortization of commitment fees, debt issuance costs and original issue discount |
|
| — |
|
| 1,596,093 |
|
Amortization of intangible assets |
|
| 44,777 |
|
| — |
|
Change in value of convertible notes payable |
|
| — |
|
| 200,004 |
|
Change in value of warrant liability |
|
| 283,688 |
|
| (3,330,254) |
|
Change in operating assets and liabilities: |
|
|
|
|
|
|
|
Accounts receivable |
|
| (189,365) |
|
| (133,752) |
|
Inventory |
|
| (257,157) |
|
| (447,537) |
|
Prepaid expenses and other current assets |
|
| 224,151 |
|
| 459,970 |
|
Other assets |
|
| 443,033 |
|
| (290,480) |
|
Accounts payable |
|
| (788,186) |
|
| 508,769 |
|
Accrued expenses |
|
| 675,829 |
|
| (744,036) |
|
Accrued interest payable |
|
| — |
|
| 1,673,793 |
|
Net cash used in operating activities |
|
| (15,728,464) |
|
| (17,122,489) |
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
Acquisition, net of cash acquired |
|
| (1,848,720) |
|
| — |
|
Purchases of property and equipment |
|
| (108,625) |
|
| (11,544) |
|
Net cash used in investing activities |
|
| (1,957,345) |
|
| (11,544) |
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
Proceeds from warrants exercised |
|
| 3,334,176 |
|
| — |
|
Proceeds from sale of common stock and warrants for purchase of common stock (January 2017) |
|
| 6,468,148 |
|
| — |
|
Proceeds from sale of convertible preferred stock (January 2017) |
|
| 12,531,000 |
|
| — |
|
Proceeds from sale of convertible preferred stock (August 2017) |
|
| 18,400,000 |
|
| — |
|
Common stock financing costs |
|
| (2,505,244) |
|
| (28,000) |
|
Preferred stock financing costs |
|
| (419,761) |
|
| — |
|
Proceeds from convertible notes payable |
|
| — |
|
| 17,250,000 |
|
Repayments on convertible notes payable |
|
| — |
|
| (446,867) |
|
Debt issuance costs |
|
| — |
|
| (726,793) |
|
Net cash provided by financing activities |
|
| 37,808,319 |
|
| 16,048,340 |
|
Net increase in cash and cash equivalents |
|
| 20,122,510 |
|
| (1,085,693) |
|
Cash and cash equivalents: |
|
|
|
|
|
|
|
Beginning of period |
|
| 3,310,787 |
|
| 7,927,240 |
|
End of period |
| $ | 23,433,297 |
| $ | 6,841,547 |
|
Supplemental disclosure: |
|
|
|
|
|
|
|
Cash paid for interest |
| $ | — |
| $ | 169,259 |
|
Noncash investing and financing activities: |
|
|
|
|
|
|
|
Issuance of convertible preferred shares and common shares for acquisition |
| $ | 26,258,963 |
| $ | — |
|
Conversion of convertible preferred shares to common stock |
| $ | 21,528,000 |
| $ | — |
|
Conversion of convertible notes and interest payable |
| $ | — |
| $ | 14,234,201 |
|
|
|
|
|
|
|
|
|
|
| Six Months Ended June 30, |
| ||||
|
| 2019 |
| 2018 |
| ||
Cash flows from operating activities: |
|
|
|
|
|
|
|
Net loss |
| $ | (20,396) |
| $ | (46,484) |
|
Loss from discontinued operations, net of tax |
|
| — |
|
| 19,795 |
|
Adjustments to reconcile net loss to net cash used in operating activities: |
|
|
|
|
|
|
|
Depreciation expense |
|
| 30 |
|
| 145 |
|
Amortization of intangible assets |
|
| 833 |
|
| 67 |
|
Impairment of intangible assets |
|
| 6,588 |
|
| 14,005 |
|
Noncash interest expense |
|
| 797 |
|
| — |
|
Fair value adjustment to embedded derivative |
|
| (481) |
|
| — |
|
Loss on extinguishment of debt |
|
| 71 |
|
| — |
|
Stock-based compensation |
|
| 1,983 |
|
| 1,550 |
|
Warrant expense |
|
| 4,257 |
|
| 145 |
|
Deferred income tax benefit |
|
| (586) |
|
| (2,591) |
|
Other noncash items |
|
| 14 |
|
| — |
|
Change in operating assets and liabilities: |
|
| — |
|
|
|
|
Accounts and other receivables |
|
| (3,709) |
|
| 43 |
|
Inventory |
|
| (363) |
|
| 348 |
|
Prepaid expenses and other current assets |
|
| (1,034) |
|
| (452) |
|
Other assets |
|
| — |
|
| 880 |
|
Accounts payable and accrued liabilities |
|
| 3,397 |
|
| 1,656 |
|
Net cash used in operating activities - continuing operations |
|
| (8,599) |
|
| (10,893) |
|
Net cash used in operating activities - discontinued operations |
|
| — |
|
| (4,931) |
|
Net cash used in operating activities |
|
| (8,599) |
|
| (15,824) |
|
Cash flows from investing activities: |
|
|
|
|
|
|
|
Purchases of property and equipment |
|
| — |
|
| (7) |
|
Net cash used in investing activities - continuing operations |
|
| — |
|
| (7) |
|
Net cash used in investing activities |
|
| — |
|
| (7) |
|
Cash flows from financing activities: |
|
|
|
|
|
|
|
Proceeds from issuance of subordinated convertible debentures |
|
| 2,000 |
|
| — |
|
Payments of debt financing costs |
|
| (21) |
|
| — |
|
Repayment of subordinated convertible debentures |
|
| (2,200) |
|
| — |
|
Proceeds from warrants exercised |
|
| 40 |
|
| 488 |
|
Proceeds from sale and issuance of equity securities |
|
| 7,616 |
|
| 9,004 |
|
Payments of equity issuance costs |
|
| (29) |
|
| (1,461) |
|
Preferred stock redemption |
|
| — |
|
| (500) |
|
Net cash provided by financing activities - continuing operations |
|
| 7,406 |
|
| 7,531 |
|
Net cash provided by financing activities |
|
| 7,406 |
|
| 7,531 |
|
Net decrease in cash and cash equivalents |
|
| (1,193) |
|
| (8,300) |
|
Cash and cash equivalents at beginning of period |
|
| 5,548 |
|
| 10,163 |
|
Cash and cash equivalents at end of period |
|
| 4,355 |
|
| 1,863 |
|
Noncash investing and financing activities: |
|
|
|
|
|
|
|
Down round adjustment for convertible preferred stock and warrants |
| $ | — |
| $ | 3,842 |
|
Conversion of common stock to convertible preferred stock |
|
| (1) |
|
| — |
|
Conversion of convertible preferred shares to common stock |
|
| — |
|
| — |
|
See accompanying notes to condensed consolidated financial statements.Condensed Consolidated Financial Statements.
57
ReShape Lifesciences Inc.
Notes to Condensed Consolidated Financial Statements
(Unaudited)
(dollars in thousands, except per share amounts; unaudited)
(1) Summary of Significant Accounting Policies
Description of Business
ReShape Lifesciences Inc. (the Company) is focused on the development and commercialization of minimally invasive medical devices to treat obesity, metabolic diseases and other gastrointestinal disorders. The Company was incorporated in the state of Minnesota on December 19, 2002 and was reincorporated in Delaware on July 22, 2004. In January 2006, the Company established EnteroMedics Europe Sárl, a wholly-owned subsidiary located in Switzerland. Prior to October 23, 2017, the Company was known as EnteroMedics Inc. While the Company is currently headquartered in St. Paul, Minnesota, in conjunction with its acquisition of ReShape Medical, Inc. (ReShape Medical) on October 2, 2017, it announced its intention to move its headquarters to San Clemente, California. See further information regarding the Company’s acquisition of ReShape Medical in Note 11, Subsequent Events.
The Company’s board of directors and stockholders approved a 1-for-70 reverse split (the Reverse Stock Split) of the Company’s outstanding common stock that became effective after trading on December 27, 2016. The Reverse Stock Split did not change the par value of the Company’s stock or the number of preferred shares authorized by the Company’s Fifth Amended and Restated Certificate of Incorporation. An amendment to the Certificate of Incorporation was also approved in connection with the Reverse Stock Split to increase the number of shares of the Company’s common stock authorized for issuance to 300 million shares, effective immediately after the Reverse Stock Split. All share and per share amounts have been retroactively adjusted to reflect the Reverse Stock Split for all periods presented.
On October 26, 2017, the Company filed a Certificate of Amendment to its Sixth Amended and Restated Certificate of Incorporation to reduce the number of authorized shares of the Company’s common stock from 300 million to 275 million
Risks and Uncertainties
The Company is focused on the development and commercialization of minimally invasive medical devices to treat obesity, metabolic diseases and other gastrointestinal disorders. vBloc® Neurometabolic Therapy (vBloc Therapy), delivered by a U.S. Food and Drug Administration (FDA)-approved pacemaker-like device called the vBloc®System, is designed to help patients feel full and eat less by intermittently blocking hunger signals on the vagus nerve.
We have a limited operating history and only recently received FDA approval to sell the vBloc System in the United States. In addition, we have regulatory approval to sell the vBloc System in the European Economic Area and other countries that recognize the European CE Mark and do not have any other significant source of revenue currently. We have devoted substantially all of our resources to the development and commercialization of the vBloc System, which was formerly known as the Maestro or vBloc Rechargeable System.
On May 22, 2017 the Company acquired the Gastric Vest System™ (Gastric Vest) through the acquisition of BarioSurg, Inc. The Gastric Vest is an investigational, minimally invasive, laparoscopically implanted medical device being studied for weight loss in obese and morbidly obese patients. The Gastric Vest wraps around a plicated stomach, emulating the effect of conventional weight-loss surgery, and is intended to enable gastric volume reduction without permanently changing patient anatomy.
On October 2, 2017 the Company acquired ReShape Medical, Inc., a privately-held medical technology company that develops, manufactures and markets the ReShape® Dual Weight Loss Balloon (the ReShape Balloon), an FDA-approved, minimally invasive intragastric balloon designed to treat obesity patients with a body mass index (BMI) between 30 and 40, with one or more related comorbid conditions. Because the closing of this acquisition was after September 30, 2017, the Company’s Consolidated Balance Sheets and Statements of Operations included with this Quarterly Report on Form 10-Q do not reflect the acquisition of ReShape Medical.
6
The Company’s products require approval from the U.S. Food and Drug Administration (FDA) or corresponding foreign regulatory agencies prior to commercial sales. The Company received FDA approval on January 14, 2015 for vBloc Therapy, delivered via the vBloc System, and has begun a controlled commercial launch at select surgical centers in the United States. The vBloc System has also received CE Mark and was previously listed on the Australian Register of Therapeutic Goods (ARTG). The ReShape Balloon received FDA approval on July 28, 2015.
The medical device industry is characterized by frequent and extensive litigation and administrative proceedings over patent and other intellectual property rights. Whether a product infringes a patent involves complex legal and factual issues, the determination of which is often difficult to predict, and the outcome may be uncertain until the court has entered final judgment and all appeals are exhausted. The Company’s competitors may assert that its products or the use of the Company’s products are covered by U.S. or foreign patents held by them.
The Company’s activities are subject to significant risks and uncertainties, including the ability to obtain additional financing, and there can be no assurance that the Company will be successful in obtaining additional financing on favorable terms, or at all. If adequate funds are not available, the Company may have to further reduce its cost structure until financing is obtained and/or delay development or commercialization of products or license to third parties the rights to commercialize products or technologies that the Company would otherwise seek to commercialize.
Basis of Presentation
The Company has prepared the accompanying condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America. The Company’s fiscal year ends on December 31.
The accompanying interim condensed consolidated financial statements and notes thereto are unaudited. Inrelated disclosures of Reshape Lifesciences Inc. (the “Company”) have been prepared pursuant to the opinionrules and regulations of the Company’s management, these statements include all adjustments, which are of a normal recurring nature, necessary to present a fair presentation. Interim results are not necessarily indicative of results for a full year. The condensed consolidated balance sheet as of December 31, 2016 was derived from audited consolidated financial statements, but does not include all disclosures required by accounting principles generally accepted in the United States of America. The information included in this Form 10-QSecurities and Exchange Commission ("SEC") and should be read in conjunction with the consolidated financial statements and notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.
Use of Estimates
The preparation of2018. Certain information and footnote disclosures normally included in financial statements prepared in conformityaccordance with generally accepted accounting principles generally accepted in the United States of America requires("GAAP") have been condensed or omitted.
In the opinion of management, to make estimates and assumptions that affect the amounts reported in theinterim consolidated condensed financial statements and accompanying notes. Actual results could differ from those estimates.
Principles of Consolidation
The accompanying condensed consolidated financial statements include the accountsreflect all adjustments considered necessary for a fair statement of the Company and its wholly-owned subsidiary.interim periods. All intercompany transactions and accounts have been eliminated in consolidation.
such adjustments are of a normal, recurring nature. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year.
Fair Value of Financial Instruments
CarryingThe carrying amounts of certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, prepaid expenses and other current assets, accounts payable and certain accrued and other liabilities approximate fair value due to their shortshort-term maturities. Certain ofRefer to Note 5 regarding the Company’s common stock warrants are required to be reported at fair value and the Company has elected to report its senior amortizing convertible notes at fair value. The fair values of common stock warrants and investments in debt and equity securities, if any, are disclosed in Note 4. The fair values of senior amortizing convertible notes (the Notes) outstanding, if any, are valued using a Binomial Lattice model.
Common Stock Warrant Liability
Common stock warrants that were issued in connection with the July 8, 2015 public offering (the Series A Warrants) and the common stock warrants issued in connection with the November 9, 2015, January 11, 2016 and
7
May 2, 2016 7% senior amortizing convertible notes (the Note Warrants) are classified as a liability in the condensed consolidated balance sheets, as the common stock warrants issued provide for certain anti-dilution protections in the event shares of common stock or securities convertible into shares of common stock are issued below the then-existing exercise price. The fair value of these common stock warrants is re-measured at each financial reporting perioddebt instruments and immediately before exercise, with any changes inNote 8 regarding fair value being recognized as a component of other income (expense) in the condensed consolidated statements of operations.
Cashmeasurements and Cash Equivalents
The Company considers highly liquid investments generally with maturities of 90 days or less when purchased to be cash equivalents. Cash equivalents are stated at cost, which approximates market value. The Company’s cash equivalents are primarily in money market funds and certificates of deposit. The Company deposits its cash and cash equivalents in high-quality credit institutions.
Inventory
The Company accounts for inventory at the lower of cost or market and records any long-term inventory as other assets in the condensed consolidated balance sheets.
Property and Equipment, Net
Property and equipment are stated at cost less accumulated depreciation and amortization. Depreciation of property and equipment is computed using the straight-line method over their estimated useful lives of five to seven years for furniture and equipment and three to five years for computer hardware and software. Leasehold improvements are amortized on a straight-line basis over the lesser of their useful life or the term of the lease. Upon retirement or sale, the cost and related accumulated depreciation or amortization are removed from the condensed consolidated balance sheets and the resulting gain or loss is reflected in the condensed consolidated statements of operations. Repairs and maintenance are expensed as incurred.
Impairment of Long-Lived Assets, Intangible Assets and Goodwill
The Company evaluates its long-lived assets, including its finite-lived intangible assets, for impairment by comparison of the carrying amounts to future net undiscounted cash flows expected to be generated by such assets when events or changes in circumstances indicate the carrying amount of an asset may not be recoverable. Should an impairment exist, the impairment loss would be measured based on the excess carrying value of the asset over the asset’s fair value or estimates of future discounted cash flows. The Company has not identified any such impairment losses to date. The Company tests Goodwill and indefinite-lived intangible assets for impairment annually as required.
Income Taxes
Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carry-forwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance for deferred income tax assets is recorded when it is more likely than not that some portion or all of the deferred income tax assets will not be realized. The Company has provided a full valuation allowance against the gross deferred tax assets. The Company’s policy is to classify interest and penalties related to income taxes as income tax expense in the condensed consolidated statements of operations.
Medical Device Excise Tax
On January 14, 2015, the Company received FDA approval for vBloc Therapy, delivered via the vBloc System, and starting in the second quarter of 2015 revenues were generated from sales in the United States. As a result, the Company is now required to pay a quarterly Medical Device Tax which is a part of the Affordable Care Act, which
8
imposes a 2.3% excise tax on the sale of certain medical devices by device manufactures, producers or importers. The excise tax was effective on sales of devices made after December 31, 2012. The Company records the Medical Device Tax as an operating expense in the condensed consolidated statements of operations. A moratorium was placed on the Medical Device Tax for 2016 and 2017.
Comprehensive Loss
Comprehensive loss is defined as the change in equity of a company during a period from transactions and other events and circumstances excluding transactions resulting from investment owners and distributions to owners. There was no difference from reported net loss for the three and nine months ended September 30, 2017 and 2016.
Revenue Recognition
Sales revenue is recognized when persuasive evidence of an arrangement exists, title or risk of loss has passed, the selling price is fixed or determinable, and collection is reasonably assured. Products are sold through direct sales or medical device distributors and revenue is recognized upon sale to a bariatric center of excellence or a medical device distributor when no right of return or price protection exists. Terms of sales to international distributors are generally EXW, reflecting that goods are shipped “ex works,” in which risk of loss is assumed by the distributor at the shipping point. A provision for returns is recorded only if product sales provide for a right of return. No provision for returns was recorded for the three and nine months ended September 30, 2017 and 2016, as the product sales recorded did not provide for rights of return.
Revenues for services are recognized when earned, subject to limitations, if any, related to multiple deliverables. We evaluate each element in these multiple-element arrangements to determine whether they represent a separate unit of accounting and recognize each element as the services are performed.
Research and Development Expenses
Research and development expenses are charged to expense as incurred. Research and development expenses include, but are not limited to, product development, clinical trial expenses, including supplies, devices, explants and revisions, quality assurance, regulatory expenses, payroll and other personnel expenses, materials and consulting costs.
Patent Costs
Costs associated with the submission of a patent application are expensed as incurred given the uncertainty of the patents resulting in probable future economic benefits to the Company.
Stock-Based Compensation
The fair value method is applied to all share-based payment awards issued to employees and where appropriate, nonemployees, unless another source of literature applies. All option grants are expensed on a straight-line basis over the vesting period.
inputs.
Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted-average number of common shares outstanding during the period. Diluted net loss per share is based on the weighted-average common shares outstanding during the period plus dilutive potential common shares calculated using the treasury stock method. Such potentially dilutive shares are excluded when the effect would be to reduce a net loss per share. The Company’s potential dilutive shares, which include outstanding common stock options and warrants, have not been included in the computation of diluted net loss per share for all periods as the result would be anti-dilutive.
9
The following table sets forth the computation of basic and diluted net loss per share for the three and nine months ended September 30, 2017 and 2016:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Three Months Ended |
| Nine Months Ended |
| ||||||||
|
| September 30, |
| September 30, |
| ||||||||
|
| 2017 |
| 2016 |
| 2017 |
| 2016 |
| ||||
Numerator: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Net loss |
| $ | (9,993,676) |
| $ | (6,522,463) |
| $ | (24,200,665) |
| $ | (18,926,390) |
|
Denominator for basic and diluted net loss per share: |
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted-average common shares outstanding |
|
| 9,470,807 |
|
| 554,028 |
|
| 7,589,239 |
|
| 273,751 |
|
Net loss per share—basic and diluted |
| $ | (1.06) |
| $ | (11.77) |
| $ | (3.19) |
| $ | (69.14) |
|
The following table sets forth the potential shares of common stock that are not included in the calculation of diluted net loss per share because to do so would be anti-dilutive as of the end of each period presented:
|
|
|
|
|
|
|
| September 30, |
| ||
|
| 2017 |
| 2016 |
|
Stock options outstanding |
| 1,331,166 |
| 1,414,918 |
|
Common shares underlying convertible preferred stock |
| 9,787,210 |
| — |
|
Warrants to purchase common stock |
| 14,308,337 |
| 3,953,413 |
|
|
|
|
|
|
|
|
| June 30, |
| ||
|
| 2019 |
| 2018 |
|
Stock options |
| 4,103 |
| 4,365 |
|
Convertible preferred stock |
| 154,543 |
| 22,474 |
|
Warrants |
| 242,709,036 |
| 28,438 |
|
The potential shares of common stock at June 30, 2019 exclude 980,969,318 of warrants issued in June 2019 that, pursuant to the terms of the warrant agreements, are not exercisable until the Company effects a reverse stock split.
Recently IssuedRecent Accounting Pronouncements
New accounting standards adopted by the Company in 2019 are discussed below or Adoptedin the related notes, where appropriate.
In February 2016, the Financial Accounting Standards
In May 2014, FASB Board ("FASB") issued Revenue from Contracts with Customers, Topic 606 (Accounting Standards UpdateASU No. 2014-09 (ASU 2014-09)), which provides a framework for2016-02 Leases (Topic 842) that amended the recognition of revenue, withguidance on leases. The amendment improves transparency and comparability among companies by recognizing lease assets and lease liabilities on the objective that recognized revenues properly reflect amounts an entity is entitled to receive in exchange for goodsbalance sheet and services. Thisby disclosing key information about leasing arrangements. The guidance will bewas effective for interim and annual reporting periodsfiscal years beginning after December 15, 2017. 2018, including interim periods within those fiscal years. Reporting entities could elect to adjust comparative periods and record the cumulative effect adjustment at the beginning of the earliest comparative period, or to not adjust comparative periods and record the cumulative effect adjustment at the effective date.
The Company intends to useadopted the new guidance as of the effective date of January 1, 2019 using the modified retrospective approach when it adoptswith no adjustments to the standard as required January 1, 2018. The Company’s accountingcomparative period presented in the financial statements. In addition, the Company elected the package of practical expedients permitted under the transition guidance to not reassess (1)
8
whether any expired or existing contracts are, or contain, leases, (2) the lease classification for revenue related to vBloc products is not expected to materially change. expired or existing leases, and (3) initial direct costs for existing leases.
The implications of the adoption of the new standardguidance resulted in the recognition of right-of-use ("ROU") assets and lease liabilities for operating leases of $1,176 as of January 1, 2019. The guidance did not have an impact on the Company's Condensed Consolidated Statements of Operations or Cash Flows. See Note 6 for disclosures related to sales of ReShape Medical’s products are currently being evaluated. Additionally, the new standard will likely require incremental revenue disclosures that may be significant. Company's leases.
In March 2016,June 2018, the FASB issued ASU No. 2018-07, Compensation – Stock Compensation (Topic 718), Improvements to EmployeeNonemployee Share-Based Payment Accounting (Accounting Standards Update No. 2016-09 (ASU 2016-09)), which is intended to simplify several aspects of the accounting for nonemployee share-based payment transactions includingby expanding the income tax consequences, classificationscope of awards as either equity or liabilities, the estimation of forfeitures, shares withheldTopic 718 to include share-based payment transactions for taxesacquiring goods and classification of shares withheld for taxes on the statement of cash flows. As part of the adoption of thisservices from nonemployees. The guidance the Company has elected to account for forfeitures of share-based awards as they occur. The Company prospectively adopted ASU 2016-09 as required on January 1, 2017 and the adoption did not have a material effect on its consolidated financial statements.
In July 2017, FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. The amendments in this update are intended to simplify the accounting for certain equity-linked financial instruments and embedded features with down round features that result in the strike price being reduced on the basis of the pricing of future equity offerings. Under the new guidance, a down round feature will no longer need to be considered when determining whether certain financial instruments or embedded features should be classified as liabilities or equity instruments. That is, a down round feature will no longer preclude equity classification when assessing whether an instrument or embedded feature is indexed to an entity's own stock. In addition, the amendments clarify existing disclosure requirements for equity-classified instruments. These amendments arewas effective for fiscal years and interim periods within those years beginning after December 15, 2018, with early adoption permitted. WeThe Company adopted this guidance effective January 1, 2019. The adoption of this guidance had no effect on the Company’s consolidated financial statements as there were no share-based payment transactions with nonemployees in 2018 and such transactions in prior years, all of which had an established measurement date, were not material.
New accounting standards not yet adopted are discussed below.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820) – Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, which modifies the disclosure requirements on fair value measurements and is intended to improve the effectiveness of disclosures, including the consideration of costs and benefits. The guidance is effective for the fiscal years and interim periods within those years beginning after January 1, 2020. Early adoption is permitted, and an entity is permitted to early adoptedadopt any removed or modified disclosures and delay adoption of additional disclosures until their effective date. The Company is evaluating the applicableeffects of ASU 2018-13 on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing ArrangementThat Is a Service Contract. The amendments in this update align the third quarter of 2017 onrequirements for capitalizing implementation costs incurred in a retrospective basis.
10
There have been no other significant changes in recent accounting pronouncements duringhosting arrangement that is a service contract with the nine months ended September 30, 2017 as comparedrequirements for capitalizing implementation costs incurred to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-Kdevelop or obtain internal-use software (and hosting arrangements that include an internal-use software license). The ASU is effective for the year endedCompany on January 1, 2020. Early adoption of the ASU is permitted. The Company is evaluating the effects of ASU 2018-15 on its consolidated financial statements.
In June 2016, the FASB issued ASU 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which is intended to provide financial statement users with more useful information about expected credit losses on financial assets held by a reporting entity at each reporting date. In May 2019, the FASB issued ASU No. 2019-05, which amended the new standard by providing targeted transition relief. The new guidance replaces the existing incurred loss impairment methodology with a methodology that requires consideration of a broader range of reasonable and supportable forward-looking information to estimate all expected credit losses. This guidance is effective for the fiscal years and interim periods within those years beginning after December 31, 2016.
15, 2019 and early adoption is permitted for fiscal years and interim periods within those years beginning after December 15, 2018.The Company is currently evaluating the effects of ASU 2016-13 on its consolidated financial statements.
(2) Liquidity and Management’s Plans
The accompanying condensed consolidated financial statements have been prepared assuming the Company will continue as a going concern. The Company currently is not generating revenue from operations that is significant relative to its level of operating expenses, and does not anticipate generatinggenerate revenue sufficient to offset operating costs and anticipates such shortfalls to continue in the short-term to mid-term. The Company has financed its operations to date principally through the sale of equity securities, debt financing and interest earned on investments. The Company’s history of operating losses and limited cash resources and lack of certainty regarding obtaining significant third-party reimbursement for the vBloc System or timing thereof, raise substantial doubt about ourits ability to continue as a going concern absent a strengthening of our cash position.
On January 23, 2017, the Company closed an underwritten public offering consisting of units of common stock, convertible preferred stock and warrants to purchase common stock. Gross proceeds of the offering were $19.0 million, prior to deducting underwriting discounts and commissions and offering expenses of $2.5 million.
On August 16, 2017, the Company closed an underwritten public offering consisting of units of Series B Convertible Preferred Stock and warrants to purchase common stock. Gross proceeds of the offering were $20.0 million, prior to deducting underwriting discounts and commissions and offering expenses of approximately $2.0 million.
During the nine months ended September 30, 2017, common stock warrants for 599,670 shares of common stock were exercised by warrant holders of warrants issued January 23, 2017 with proceeds to the Company of $3.3 million.
concern. As of SeptemberJune 30, 2017,2019, the Company had $23.4 million$4,355 of cash and cash equivalents to fund its operations through 2017 early 2018.
equivalents.
The Company’s anticipated operations include plans to (i) continue to integrate the sales and operations of the Company with the newlyLap-Band product line acquired ReShape Medical in order to expand sales of both the ReShape Balloon and vBloc as well as to obtain cost savings synergies,December 2018; (ii) expand the controlled commercial launch of vBloc Therapy, delivered via the vBloc System, (iii) continue development of the GastricReShape Vest, (vi)(iii) seek opportunities to leverage the Company’s intellectual property portfolio and custom development services to
9
provide third party sales and licensing opportunities, and (v)(iv) explore and capitalize on synergistic opportunities to expand our portfolio and offer future minimally invasive treatments and therapies in the obesity continuum of care. The Company believes that it has the flexibility to manage the growth of its expenditures and operations depending on the amount of available cash flows, which could include reducing expenditures for marketing, clinical and product development activities. However, the Company will ultimately need to achieve sufficient revenues from product sales and obtain additional debtequity or equitydebt financing to support its operations.
Management is currently pursuing various funding options, including seeking additional equity or debt financing as well as a strategic merger or other transaction to obtain additional funding or expand itsto support the expansion of Lap-Band product linesales and to continue the development of, and to successfully commercialize, the ReShape Balloon, the vBloc System and the Gastric Vest. While the acquisition of ReShape Medicalthe Lap-Band product line does provide incremental revenues and cash flows to the Company, the cost to further develop and commercializesupport the clinical trials of the ReShape BalloonVest is expected to significantly exceed revenuesinternally generated cash flows for the foreseeable future. While there can be no assurance that the Company will be successful in its efforts, the Company has a long history of raising equity financing to fund its development activities. Should the Company be unable to obtain adequate financing in the near term, the Company’s business, result of operations, liquidity and financial condition would be materially and negatively affected, and the Company would be unable to continue as a going concern. Additionally, there can be no assurance that, assuming the Company is able to strengthen its cash position, it will achieve sufficient revenue or profitable operations to continue as a going concern.
(3) Discontinued Operations
During the fourth quarter of 2018, the Company sold substantially all of the assets exclusively related to its ReShape Balloon product line, which consisted of inventory, property and equipment and the related intellectual property underlying the intangible assets. The operating results of the ReShape Balloon product line have been reflected as discontinued operations in the Condensed Consolidated Financial Statements. In addition, the cash flows associated with discontinued operations are presented separately in the accompanying Condensed Consolidated Statements of Cash Flows.
There were no assets associated with the ReShape Balloon product line at June 30, 2019 and December 31, 2018. As described in Note 4 of the Company's Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended December 31, 2018, the Company recorded an impairment charge of $13,182 in the second quarter of 2018 for the full write-down of the goodwill that had been recorded in connection with its acquisition in October 2017 of ReShape Medical, Inc. (“ReShape Medical”). The ReShape Balloon product line was the primary operating activity of ReShape Medical. The components of loss from discontinued operations for the three and six months ended June 30, 2018 consisted of the following:
|
|
|
|
|
|
|
|
| Three Months Ended |
| Six Months Ended | ||
|
| June 30, 2018 | ||||
Revenue |
| $ | 644 |
| $ | 1,455 |
Loss from discontinued operations before income taxes |
|
| (15,939) |
|
| (19,795) |
Income tax benefit |
|
| — |
|
| — |
Loss from discontinued operations, net of tax |
| $ | (15,939) |
| $ | (19,795) |
(4) Supplemental Balance Sheet Information
11
(3) Acquisition
On May 22, 2017,selected captions in the Company entered into an Agreement and Plan of Merger (the "Merger Agreement") to acquire allcondensed consolidated balance sheets consisted of the ownership interests of BarioSurg, Inc. ("BarioSurg"), a company developing the Gastric Vest System (the “Gastric Vest”), an investigational, minimally invasive, laparoscopically implanted medical device being studied for weight loss in obese and morbidly obese patients. following:
The consideration paid by the Company for all of the outstanding shares of capital stock and outstanding options of BarioSurg consisted of: (i) 1.38 million shares of common stock, par value $0.01 per share, of the Company ("Company Common Stock"), (ii) 1.0 million shares of newly created conditional convertible preferred stock, par value $0.01 per share, of the Company ("Company Preferred Stock"), which shares will convert into 5.0 million shares of Company Common Stock subject to and contingent upon the post-closing approval of the Company's stockholders in accordance with the NASDAQ Stock Market Rules, and (iii) $2.0 million in cash. At the closing of the Merger, 100,018 shares of Company Preferred Stock were deposited with an escrow agent to fund-post closing indemnification obligations of BarioSurg’s former stockholders. The total consideration paid by the Company, preliminarily valued at $28.3 million, includes: (a) $2.0 million in cash paid from our existing cash balances and (b) $26.3 million from the issuance of Company Common Stock and Company Preferred Stock. The preliminary valuation of the Company Common Stock and Company Preferred Stock took into account (i) the conversion ratio of the Company Preferred Stock, (ii) the average closing prices of our common stock on the NASDAQ Stock Market on the date the transaction was announced and the three trading days following the announcement, and (iii) a 19% discount for lack of marketability related to the shares issued in the transaction.
The purchase price consideration of $28.3 million does not include expenses of $131,000 and $367,000 for legal, accounting, audit, valuationAccounts and other services that were incurred during the three and nine months ended September 30, 2017 as part of the transaction and were expensed as incurred.
The following table summarizes the estimated fair values of the assets acquired and liabilities assumed as a result of the BarioSurg acquisition. The excess of the cost of the acquisition over the fair value of assets acquired was recorded as goodwill. The assessment of fair value is preliminary and is based on information that was available at the time the consolidated condensed financial statements were prepared. Accordingly, the allocation of purchase price is preliminary and, therefore, subject to adjustment in future periods.receivables, net:
|
|
|
|
Cash |
| $ | 151,280 |
Property and equipment |
|
| 3,000 |
Goodwill |
|
| 6,397,671 |
In Process Research & Development |
|
| 20,720,939 |
Trademarks/tradenames |
|
| 1,090,363 |
Covenant not to compete |
|
| 75,884 |
Other assets |
|
| 5,826 |
Current liabilities assumed |
|
| (186,000) |
Net assets acquired |
| $ | 28,258,963 |
|
|
|
|
|
|
|
|
| June 30, |
| December 31, | ||
|
| 2019 |
| 2018 | ||
Accounts receivable |
| $ | 2,209 |
| $ | 510 |
Receivables, Apollo |
|
| 2,416 |
|
| 407 |
Total accounts and other receivables |
| $ | 4,625 |
| $ | 917 |
We believe that the amount of goodwill relative to identifiable intangible assets relates to several factors including (i) potential synergies related to market opportunities for multiple product offerings, (ii) future technology, and (iii) initial relationships and awareness of the Gastric Vest.
In-process research and development (“IPR&D”) consists of the Gastric Vest, which has not yet been clinically tested in the United States and has not yet been approved by the FDA. Acquired IPR&D assets are initially recognized at fair value and are classified as indefinite-lived assets until the successful completion or abandonment of the associated research and development efforts. The value assigned to IPR&D was determined by estimating the net cash flows from the Gastric Vest development project and discounting the net cash flows to their present value. During the development period, this asset will not be amortized as charges to earnings; instead, this asset will be subject to periodic impairment testing. Upon successful completion of the development process for the acquired IPR&D, the asset would then be considered a finite-lived intangible asset and amortization will commence. Trademarks/tradenames were valued using
12
the relief from royalty method and are being amortized over a 10-year period. The covenant not to compete is being amortized over a three-year period. The values of these intangible assets are considered Level 3 measurements.
The results of this acquisition, a $443,000 loss for the 2017 year-to-date period through September 30, is included in our consolidated operations beginning May 22, 2017.
Unaudited Pro Forma Information
The following unaudited pro forma financial information presents our combined results of operations as if the acquisition of BarioSurg and the related issuance of Company Common Stock had occurred on January 1, 2016. Pro forma information reflects adjustments that give effect to pro forma events that are directly attributable to the acquisition, factually supportable and expected to have a continuing impact on the combined results following the acquisition. In addition, the unaudited pro forma financial information do not purport to be indicative of the results that would have actually been obtained if the acquisition had occurred as of January 1, 2016 or that may be obtained in the future, and do not reflect future synergies, integration costs, or other such costs or savings.
|
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|
|
|
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|
|
|
|
| Three Months Ended September 30, |
| Nine Months Ended September 30, | ||||||||
|
|
| 2017 |
|
| 2016 |
|
| 2017 |
|
| 2016 |
Revenues |
| $ | 360,020 |
| $ | 296,760 |
| $ | 493,120 |
| $ | 644,760 |
Net loss |
| $ | (9,895,138) |
| $ | (6,691,689) |
| $ | (24,230,493) |
| $ | (19,406,642) |
Net loss per share—basic and diluted |
| $ | (1.04) |
| $ | (3.46) |
| $ | (2.92) |
| $ | (11.73) |
The unaudited pro forma results include adjustments due to increases in amortization expense and acquisition related costs. The per share unaudited pro forma results also reflect adjustment of weighted average common shares outstanding to reflect the assumed issuance of 1.38 million shares of Company Common Stock as of January 1, 2016.
(4) Fair Value Measurements
Fair value of financial assets and liabilities is defined as the price that would be received to sell an asset or transfer a liability in an orderly transaction between market participants at the measurement date. A fair value hierarchy has been established that prioritizes the inputs to valuation techniques used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurements) and the lowest priority to unobservable inputs (Level 3 measurements). The three levels of the fair value hierarchy are described below:
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|
|
The Company’s assets that are measured at fair value on a recurring basis are classified within Level 1 or Level 2 of the fair value hierarchy. The Company does not hold any recurring assets that are measured at fair value using Level 3 inputs.
The Company did not hold any short-term investments classified as available for sale or held to maturity as of September 30, 2017 and December 31, 2016.
1310
The fair value of the Company’s common stock warrant liability is calculated using a Black-Scholes valuation model and is classified as Level 2 in the fair value hierarchy. The fair values are presented below along with the valuation assumptions:
|
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|
|
|
|
|
|
|
|
| Series A Warrants |
| |||
|
| September 30, 2017 |
| December 31, 2016 |
| ||
Risk-free interest rates |
|
| 1.31 | % |
| 1.20 | % |
Expected life |
|
| 15 | months |
| 24 | months |
Expected dividends |
|
| — | % |
| — | % |
Expected volatility |
|
| 194.28 | % |
| 122.03 | % |
Fair value |
| $ | 2,159 |
| $ | 36,000 |
|
The following were the fair value assumptions used by the Company in calculating values of Note Warrants as of December 31, 2016:
|
|
|
|
|
|
|
|
|
|
|
|
| December 31, 2016 | ||||||||
|
| November 2015 Note Warrants |
| January 2016 Note Warrants |
| May 2016 Note Warrants |
| |||
Risk-free interest rates |
|
| 1.47 | % |
| 1.93 | % |
| 1.93 | % |
Expected life |
|
| 46 | months |
| 48 | months |
| 52 | months |
Expected dividends |
|
| — | % |
| — | % |
| — | % |
Expected volatility |
|
| 102.29 | % |
| 108.57 | % |
| 106.37 | % |
Fair value |
| $ | 449 |
| $ | 1,633 |
| $ | 1,037 |
|
The following table summarizes fair value measurements of the Series A Warrants and Note Warrants by level at December 31, 2016 and September 30, 2017:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Level 1 |
| Level 2 |
| Level 3 |
| Total | ||||
Common stock warrants at December 31, 2016 |
| $ | — |
| $ | 39,119 |
| $ | — |
| $ | 39,119 |
Common stock warrants at September 30, 2017 |
| $ | — |
| $ | 2,159 |
| $ | — |
| $ | 2,159 |
During the three and nine months ended September 30, 2016, the Company had amounts outstanding from 7% senior amortizing convertible notes (the Notes) related to Note issuances on November 9, 2015 (the First Closing) and January 11, 2016 (the Second Closing) and May 2, 2016 (the Third Closing), when the Company issued Notes with principal amounts of $1.5 million, $11.0 million and $6.25 million, respectively. As of December 31, 2015, the fair value of the outstanding Notes from the First Closing was determined to be $1.3 million. The fair value of the Notes issued with the Second Closing was determined to be $9.9 million on the January 11, 2016 issue date and $2.4 million on September 30, 2016. The fair value of the Notes issued with the Third Closing was determined to be $6.0 million on the May 2, 2016 issue date and $3.2 million on September 30, 2016. The fair values were calculated using a Binomial Lattice model and the following assumptions:
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|
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|
|
| November 2015 Notes |
| January 2016 Notes | ||||||||||||
|
| September 30, 2016 |
|
| December 31, 2015 |
|
| September 30, 2016 |
|
| January 11, 2016 |
| ||||
Risk-free interest rates |
|
| N/A |
|
|
| 1.11 | % |
|
| 0.65 | % |
|
| 1.01 | % |
Expected life |
|
| N/A |
|
|
| 1.86 | years |
|
| 1.11 | years |
|
| 1.83 | years |
Expected dividends |
|
| N/A |
|
|
| — | % |
|
| — | % |
|
| — | % |
Expected volatility |
|
| N/A |
|
|
| 57.5 | % |
|
| 70.0 | % |
|
| 60.0 | % |
Fair value per share of common stock |
|
| N/A |
|
| $ | 0.03 |
|
| $ | 0.002 |
|
| $ | 0.02 |
|
|
|
|
|
|
|
|
|
|
|
| May 2016 Notes | ||||||
|
| September 30, 2016 |
|
| May 2, 2016 |
| ||
Risk-free interest rates |
|
| 0.65 | % |
|
| 0.69 | % |
Expected life |
|
| 1.11 | years |
|
| 1.52 | years |
Expected dividends |
|
| — | % |
|
| — | % |
Expected volatility |
|
| 70.0 | % |
|
| 65.0 | % |
Fair value per share of common stock |
| $ | 0.002 |
|
| $ | 0.01 |
|
14
(5) InventoryPrepaid expenses and other current assets:
|
|
|
|
|
|
|
|
| June 30, |
| December 31, | ||
|
| 2019 |
| 2018 | ||
Prepaid contract research organization expenses |
| $ | 1,454 |
| $ | 1,064 |
Prepaid insurance |
|
| 659 |
|
| 58 |
Other current assets |
|
| 190 |
|
| 147 |
Total prepaid expenses and other current assets |
| $ | 2,303 |
| $ | 1,269 |
FromAccounts payable and accrued liabilities:
|
|
|
|
|
|
|
|
| June 30, |
| December 31, | ||
|
| 2019 |
| 2018 | ||
Accounts payable |
| $ | 3,309 |
| $ | 1,558 |
Payables, Apollo |
|
| 928 |
|
| 69 |
Professional service related expenses |
|
| 3,380 |
|
| 3,095 |
Payroll related expenses |
|
| 1,490 |
|
| 1,146 |
Other accrued liabilities |
|
| 746 |
|
| 588 |
Total accounts payable and accrued liabilities |
| $ | 9,853 |
| $ | 6,456 |
In connection with the Company’s inception, inventoryDecember 2018 acquisition of the Lap-Band product line from Apollo Endosurgery, Inc. (“Apollo”), the Company entered into transition services, supply and distribution agreements with Apollo. The receivables from, and payables to, Apollo are primarily related purchases had been usedto services performed under these agreements. During the second quarter of 2019, the invoicing and collection of Lap-Band orders from customers in the United States and Canada were transitioned to the Company. Apollo will continue to serve as the Company’s distributor of Lap-Band product in certain other geographical areas outside the United States for up to one year from the acquisition date. In addition, for a period of up to 24 months from the acquisition date, Apollo issues purchase orders and procures certain accessory Lap-Band products from third-party suppliers on the Company’s behalf. Remittances from and to Apollo are subject to a reconciliation of the credits/charges for services performed under the agreements.
(5) Impairment of Intangible Assets
Second Quarter 2019
Indefinite-lived intangible assets consist of in-process research and development related activities(“IPR&D”) for the ReShape Vest recorded in connection with the Company’s acquisition of BarioSurg, Inc. (“BarioSurg”) in May 2017. The Company has completed the feasibility study for the ReShape Vest and had accordingly been expensed as incurred. In December 2011,began clinical trials in Europe in 2018. During the second quarter of 2019, the Company began receiving ARTG listings for componentsperformed a qualitative impairment analysis of the vBloc Rechargeable System fromIPR&D. Due to delays in the Australian Therapeutic Goods Administration, withclinical trials experienced during the final components being listed onfirst six months of 2019, the ARTG in January 2012.Company revised its expectations of when revenues would commence for the ReShape Vest, thus reducing the projected near-term future net cash flows related to the ReShape Vest. As a result, the Company determined certain assets were recoverable as inventory beginning in December 2011. The Company accounts for inventory at the lower of cost or market and records any long-term inventory as other assets in the condensed consolidated balance sheets. There was $1.1 million and $676,000 of long-term inventory, primarily consisting of raw materials, as September 30, 2017 and December 31, 2016, respectively.
Current inventory consistsperformed a quantitative impairment analysis of the following as of:
|
|
|
|
|
|
|
|
| September 30, |
| December 31, | ||
|
| 2017 |
| 2016 | ||
Raw materials |
| $ | 207,758 |
| $ | 335,606 |
Work-in-process |
|
| 1,362,399 |
|
| 1,437,957 |
Finished goods |
|
| 16,472 |
|
| 16,015 |
Inventory |
| $ | 1,586,629 |
| $ | 1,789,578 |
(6) CommitmentsIPR&D and Contingencies
Operating Lease
recorded an impairment charge of $6,588 for the excess of the carrying value over the estimated fair value. The fair value of the IPR&D was estimated using an income approach which included discounting the revised projected future net cash flows to their present value.
The Company rentsalso assessed the recoverability of finite-lived intangible assets and did not identify any impairment as a result the performance of this analysis.
Second Quarter 2018
As described in Note 8 of the Company's Consolidated Financial Statements included in its headquarters office, warehouse and laboratory facilities underAnnual Report on Form 10-K for the year ended December 31, 2018, subsequent to the Company’s registered direct securities offering on
11
April 3, 2018, the price of the Company’s common stock declined significantly. Management determined that this event was an operating lease, which was originally set to expire on September 30, 2015. On August 25, 2015,indicator of potential impairment as the magnitude of the decline indicated that the net equity of the Company entered intomay be in excess of its fair market value and conducted an amendment extendingimpairment analysis during the termsecond quarter of 2018. As a result, the Company recorded an impairment charge of $14,005 for the full write-down of the operating leasegoodwill recorded in connection with its acquisition of BarioSurg. In addition, as described in Note 3, discontinued operations for the three years until Septemberand six months ended June 30, 2018 include a goodwill impairment charge for the full write-down of the goodwill recorded in connection with monthly base rent ranging from $18,925 to $20,345.
With the acquisition of BarioSurg, the Company also leases space in Lake Forest, California under an operating lease with monthly base rent of approximately $2,200 per month through September 30, 2018.
With the October 2, 2017Company’s acquisition of ReShape Medical,Medical.
In conjunction with the Company’s evaluation of goodwill for impairment in the second quarter of 2018, the Company performed a qualitative impairment analysis on indefinite-lived intangible assets other than goodwill, andassessed the recoverability of finite-lived intangible assets. The Company did not identify any impairments of such indefinite-lived or finite-lived intangible assets as a result the performance of these analyses.
(6) Debt
Asset Purchase Consideration Payable
The asset purchase consideration payable related to the Company’s December 2018 acquisition of the Lap-Band product line from Apollo was initially recorded at net present value using a discount rate of 5.1%. The asset purchase consideration payable is secured by a first security interest in substantially all of the Company’s assets. At June 30, 2019, the aggregate carrying value of the current and noncurrent asset purchase consideration payable of $6,475, as adjusted for accretion of interest, and due to the first security interest held by Apollo, approximates fair value.
Convertible Subordinated Debentures
On March 29, 2019, the Company completed a private placement with certain healthcare focused institutional investors for the sale of secured subordinated original issue discount convertible debentures (“debentures”) for a purchase price of $2,000. The debentures had a maturity of June 28, 2019 and a face amount of $2,200, reflecting a 10% original issue discount. The Company recorded an additional debt discount and a derivative liability for the fair value of the bifurcated embedded conversion features discussed below. The initial carrying amount of the debentures was recorded net of discounts and deferred financing costs of $1,498. The Company repaid the debentures on June 20, 2019 at their face amount of $2,200 with proceeds from an equity financing which closed on June 18, 2019. In connection with the early repayment of the debentures, the Company recorded a loss on extinguishment of debt of $71, which consisted of the unamortized debt discount and deferred financing costs.
The debentures contained a conversion feature that provided that, at any time after June 28, 2019, if the debentures had not been repaid, but subject to certain investor ownership limitations, the debentures were convertible into shares of common stock at a conversion price equal to the lesser of $0.33 and 80% of the average of the lowest two volume weighted average prices of the Company’s common stock during the 20 trading days prior to conversion. The Company analyzed the conversion features embedded in the debentures and determined that bifurcation and liability classification was required under ASC 815 due to the variable number of shares issuable upon conversion. The fair value of the bifurcated embedded conversion features was determined to be $481 as of the issuance date using a Monte Carlo model and primarily Level 3 inputs. Upon the closing of the Company’s equity financing and the Company’s planned use of a portion of the proceeds to repay the debentures, the fair value of the embedded derivative liability was reduced to zero as the conversion feature was no longer available. The fair value adjustment to the embedded derivative liability of $481 was recorded as a reduction to Interest Expense for the three and six months ended June 30, 2019.
In connection with the financing, the Company amended the exercise price of warrants to purchase up to 8 million shares of common stock held by the investors that were issued on November 28, 2018 from $1.50 per share to $0.01 per share. The value attributable to the exercise price reduction of $130 was recorded in Warrant Expense for the six months ended June 30, 2019 and was estimated using the Black Scholes option pricing model using a risk-free interest rate of 2.2%, an expected term of 4.7 years, expected dividends of zero and expected volatility of 204.4%.
(7) Leases
On the date of adoption of Topic 842, the Company had noncancelable operating leases separatefor office and manufacturing/warehouse space in San Clemente, California.California and noncancelable operating leases for certain office equipment that expire at various
12
dates through 2022. The Company does not have any short-term leases or financing lease arrangements and there have been no lease modifications. Certain of the Company’s equipment leases include variable lease payments that are adjusted periodically based on actual usage. Lease and non-lease components are accounted for separately.
Operating lease costs for the three and six months ended June 30, 2019 were $121 and $241, respectively. Variable lease costs were not material.
Supplemental information related to operating leases was as follows:
|
|
|
|
|
Balance Sheet Information at June 30, 2019 |
|
|
|
|
Operating lease ROU assets |
| $ | 963 |
|
|
|
|
|
|
Operating lease liabilities, current portion |
| $ | 343 |
|
Operating lease liabilities, long-term portion |
|
| 626 |
|
Total operating lease liabilities |
| $ | 969 |
|
|
|
|
|
|
Cash Flow Information for the Six Months Ended June 30, 2019 |
|
|
|
|
Cash paid for amounts included in the measurement of operating leases liabilities |
| $ | 234 |
|
Maturities of operating lease for office space has a term that runs throughliabilities at June 30, 2022 with base rent2019 were as follows:
|
|
|
|
|
Twelve months ending June 30, |
|
|
|
|
2020 |
| $ | 384 |
|
2021 |
|
| 328 |
|
2022 |
|
| 332 |
|
Total lease payments |
|
| 1,044 |
|
Less: imputed interest |
|
| 75 |
|
Total lease liabilities |
| $ | 969 |
|
|
|
|
|
|
Weighted-average remaining lease term at end of period (in years) |
|
| 2.8 |
|
Weighted-average discount rate at end of period |
|
| 5.1 | % |
Disclosures related to periods prior to adopting the new lease guidance
Future minimum lease commitments under noncancelable operating leases as of approximately $24,600 per month and with annual rent escalations of approximately 3%. The operating lease for manufacturing/warehouse space has a term that runs through OctoberDecember 31, 2019 with base rent of approximately $10,900 per month.2018 were as follows:
|
|
|
|
Year ending December 31, |
|
|
|
2019 |
| $ | 449 |
2020 |
|
| 332 |
2021 |
|
| 331 |
2022 |
|
| 166 |
Total |
| $ | 1,278 |
Total rent expense recognized for each(8) Equity
As described in Note 12 of the three month periodsCompany's Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended SeptemberDecember 31, 2018, certain of the Company’s issuances of convertible preferred stock and warrants contain non-standard down round features which result in adjustments to the conversion price of the preferred stock and exercise price of the warrants in the event of future stock sales at a lower unit price. As of June 30, 2019, warrants issued to investors in connection with the sale of convertible preferred stock in August 2017 and 2016warrants issued to investors in connection with the sale of common stock in June, July and August 2018, as amended, contain
13
such down round features. At June 30, 2019, the exercise price of warrants with these down round features was $64,893$0.02 per share, as last reset effective with a direct financing completed on June 18, 2019.
Down round adjustments were not material during the three and $58,905six months ended June 30, 2019. During the three and six months ended June 30, 2018, the Company recorded a total of $3,842 of down round adjustments attributable to changes in the conversion price of convertible preferred stock and reductions in the exercise price of warrants. The value attributable to the warrant exercise price reductions in the three and six months ended June 30, 2018 was estimated using the Black Scholes model using risk-free interest rates ranging from 2.13% to 2.81%; expected lives ranging from less than one year to 6.2 years; expected dividends of zero and expected volatility ranging from 111.63% to 126.38%.
The Company had the following equity transactions during the six months ended June 30, 2019 and 2018:
June 2019 Issuance of Common Stock and Warrants
On June 18, 2019, the Company completed a private placement with certain healthcare focused institutional investors for the sale of 15,600,000 shares of common stock at a purchase price of $0.02 per share and series C prefunded warrants to purchase 384,400,000 shares of common stock at a purchase price of $0.019 per share. The exercise price of each pre-funded warrant is $0.001 per share. The Company also issued series A warrants to purchase 400,000,000 shares of common stock at an exercise price of $0.020 per share and series B warrants to purchase 400,000,000 shares of common stock at an exercise price of $0.022 per share. Net proceeds from the private placement were $6,873 after deducting placement agent fees and other transaction costs. In connection with the registered direct offering, the placement agent received warrants to purchase 28,000,000 shares of common stock at an exercise price of $0.025 per share. The warrants issued to the placement agent are not exercisable until after the Company effects a reverse stock split.
The prefunded series C and the series A and B warrants were exercisable upon the closing of the nine-month periods was $185,436 and $176,175. At September 30, 2017, future minimum payments forprivate placement; however, until the Company includingeffects a reverse stock split, the lease obligations relatednumber of warrants that may be exercised is limited to the October 2, 2017 acquisitionnumber of ReShape Medical (see also Note11, Subsequent Events)available unissued authorized shares, as defined in the warrant agreements (“Issuable Maximum”). Because the warrant holders may elect to exercise any of the series C prefunded or series A and B warrants up to their pro rata share of the Issuable Maximum, the $7,304 in gross proceeds from the sale of the series C prefunded warrants was recorded as a liability. As a result of the liability treatment of the prefunded warrants, the Company included $714 of the transaction costs in Other, net in the Condensed Consolidated Statements of Operations.
The series A and B warrants, series C prefunded warrants and common stock issued contain variable price features until the Company effects a reverse stock split. As a result, the total number of the shares of common stock and series C prefunded warrants purchased and the exercise prices of the series A and B warrants are not fixed until after the Company effects a reverse stock split. The Company analyzed the variable price features and established a warrant liability at the issuance date of $15,966. As the initial value of the warrant liability exceeded the proceeds received from the equity offering, the excess value of $8,340 was recorded as follows:Warrant Expense. The Company revalued the warrant liability at June 30, 2019 and recorded the decrease in fair value of $4,213 as a reduction of Warrant Expense in the Condensed Consolidated Statements of Operations. The fair values of the warrant liability were determined using a Monte Carlo model and primarily Level 3 inputs.
February 2019 Conversion of Common Stock into New Series of Convertible Preferred Stock
|
|
|
|
Year ending December 31, |
|
|
|
Remaining three months of 2017 |
| $ | 173,832 |
2018 |
|
| 633,695 |
2019 |
|
| 419,082 |
2020 |
|
| 319,262 |
2021 |
|
| 327,949 |
2022 |
|
| 165,061 |
|
| $ | 2,038,881 |
On February 1, 2019, pursuant to an exchange agreement with Sabby Volatility Warrant Master Fund, Ltd. (“Sabby”) 1,192,000 shares of the Company’s common stock were exchanged for an aggregate of 1,192,000 shares of series E convertible preferred stock, par value $0.01 per share (“Series E Preferred Stock”) in a noncash transaction. Each share of Series E Preferred Stock was convertible into one share of common stock at Sabby’s election. In April 2019, all shares of Series E Preferred Stock were converted into an equal number of shares of common stock.
Conversion of Series B Convertible Preferred Stock into Common Stock
During the six months ended June 30, 2019, 156 shares of Series B convertible preferred stock (“Series B Preferred Stock”) were converted into 124,800 shares of common stock. At June 30, 2019, the remaining 3 shares of Series B Preferred stock are convertible into 150,000 shares of common stock.
1514
June 2018 Issuances of Common Stock and Warrants
On June 21, 2018, the Company completed a registered direct offering which included the sale of 3,354 shares of common stock at a purchase price of $429.80 per share per share and warrants to purchase 3,354 shares of common stock at a purchase price of $17.50 per share. The initial exercise price of each warrant was $431.20 per share. In connection with the registered direct offering, the placement agent received warrants to purchase 163 shares of common stock at an exercise price of $558.60 per share. Net proceeds from the registered direct offering were $1,269, after deducting placement agent fees and other transaction costs. The Company used $500 of the net proceeds of the offering to redeem 500 of the then currently 5,250 outstanding shares of its series D convertible preferred stock, which the Company agreed to as an inducement to obtain the required consent of the holder of series D convertible preferred stock for the Company to complete the offering.
On June 9, 2018, the Company completed a registered direct offering which included the sale of 2,676 shares of common stock at a purchase price of $548.80 per share per share and warrants to purchase 2,007 shares of common stock at a purchase price of $17.50 per share. The initial exercise price of each warrant was $550.20 per share. In connection with the registered direct offering, the placement agent received warrants to purchase 188 shares of common stock at an exercise price of $701.40 per share. Net proceeds from the registered direct offering were $1,232, after deducting placement agent fees and other transaction costs.
April 2018 Issuance of Convertible Preferred Stock and Warrants
On April 3, 2018 the Company completed a registered direct offering which included the sale of 6,000 shares of series D convertible preferred stock, par value $0.01 per share (“Series D Preferred Stock”), at a purchase price of $1,000 per share and warrants to purchase 16,667 shares of common stock at an initial exercise price of $1,575 per share. Net proceeds from the registered direct offering were $5,081, after deducting placement agent fees and other transaction costs. In April 2019, the remaining warrants to purchase 16,366 shares of common stock, net of the warrants exercised in May 2018 as discussed in Note 8, expired in accordance with their terms.
In addition to the shares of Series D Preferred Stock redeemed in connection with the registered direct offering completed on June 21, 2018, 750 shares of the Series D Preferred Stock were converted into 477 shares of common stock during the three and six months ended June 30, 2018.
(9) Warrants
On May 24, 2018, an institutional investor agreed to exercise an aggregate of 751 warrants to purchase common stock in exchange for a reduction in the warrant exercise price. The warrant exercise was accounted for as a warrant inducement and the related fair value adjustment to the exercised warrants of $146 was recorded in Warrant Expense in the Consolidated Statements of Operations for the three and six months ended June 30, 2018. The value attributable to the exercise price reductions was estimated using the Black Scholes option pricing model using risk-free interest rates ranging from 2.28% to 2.65%; expected terms ranging from less than one year to 3.7 years; expected dividends of zero and expected volatility ranging from 120.44% to 142.78%.
(10) Revenue Disaggregation and Operating Segments
The following table presents the Company’s revenue disaggregated by product and geography:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Three Months Ended June 30, 2019 |
| Three Months Ended June 30, 2018 | ||||||||||||||
|
| U.S. |
| OUS * |
| Total |
| U.S. |
| OUS |
| Total | ||||||
Lap-Band product |
| $ | 4,010 |
| $ | 440 |
| $ | 4,450 |
| $ | — |
| $ | — |
| $ | — |
ReShape vBloc product |
|
| — |
|
| — |
|
| — |
|
| 10 |
|
| — |
|
| 10 |
Total |
| $ | 4,010 |
| $ | 440 |
| $ | 4,450 |
| $ | 10 |
| $ | — |
| $ | 10 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Six Months Ended June 30, 2019 |
| Six Months Ended June 30, 2018 | ||||||||||||||
|
| U.S. |
| OUS * |
| Total |
| U.S. |
| OUS |
| Total | ||||||
Lap-Band product |
| $ | 7,076 |
| $ | 448 |
| $ | 7,524 |
| $ | — |
| $ | — |
| $ | — |
ReShape vBloc product |
|
| — |
|
| — |
|
| — |
|
| 149 |
|
| — |
|
| 149 |
Total |
| $ | 7,076 |
| $ | 448 |
| $ | 7,524 |
| $ | 149 |
| $ | — |
| $ | 149 |
15
*The next largest individual country outside the U.S. was Australia, which was 9.5% and 5.6% of total revenues for the three months and six months ended June 30, 2019 and 2018, respectively.
As described in Note 4 of the Company's Consolidated Financial Statements included in its Annual Report on Form 10-K for the year ended December 31, 2018, the Company acquired the Lap-Band product line in December 2018. As a result of the acquisition of the Lap-Band product line, the Company is no longer actively marketing the ReShape vBloc Clinical Trialsproduct.
Operating Segments
The Company’s operating segments currently consist of the Lap-Band segment and the ReShape Vest segment. These two operating segments are reported based on the financial information provided to the Chief Operating Decision Maker (the Chief Executive Officer, or “CODM”). The Company’s CODM evaluates segment performance based on gross profit. The Company’s CODM does not use operating segment assets information to allocate resources or to assess performance of the operating segments and thus total segment assets have not been disclosed
The Company continuesacquired the established Lap-Band product line in December 2018, and the Lap-Band product line accounted for all of the Company’s revenues and gross profit for the three and six months ended June 30, 2019. There were no revenues or gross profit recorded for the ReShape Vest operating segment for the three months and six months ended June 30, 2019 and 2018 because the ReShape Vest is still in the development stage.
The Company’s CODM no longer evaluates performance related to evaluateReShape vBloc, as revenues and gross profit during each of the three months ended June 30 and September 30, 2018 were insignificant, and there have been no revenues or gross profit associated with the ReShape vBloc Systemproduct since September 30, 2018. In addition, the Company is no longer actively marketing the ReShape vBloc product.
(11) Income Taxes
In connection with the impairment of IPR&D discussed in human clinical trials, includingNote 5, which resulted in a reduction in the EMPOWER trialdeferred tax liability associated with the indefinite-lived intangible asset, the Company recorded an income tax benefit of $586 for the three and ReCharge trial. Bothsix months ended June 30, 2019. The income tax benefit is net of an increase to the deferred tax valuation allowance of $1,052 for the portion of the deferred tax liability reversal that had been netted with the deferred tax asset associated with U.S. federal net operating loss carryforwards that do not expire.
The income tax benefit from continuing operations for the three and six months ended June 30, 2018 of $1,209 and $2,591, respectively, reflects the tax impact of the net operating losses from continuing operations generated in the periods which have an indefinite carryover period. A portion of these clinical trials require patientsnet operating losses were supported by expected taxable income from the reversal of indefinite-lived intangibles, such that they are more likely than not to be followed outrealized.
(12) Stock-based Compensation
Stock-based compensation expense related to 60 months.stock options issued under the ReShape Lifesciences Inc. Second Amended and Restated 2003 Stock Incentive Plan (the “Plan”) and as inducement grants for the three and six months ended June 30, 2019 and 2018 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
| Three Months Ended |
| Six Months Ended | ||||||||
|
| June 30, |
| June 30, | ||||||||
|
| 2019 |
| 2018 |
| 2019 |
| 2018 | ||||
Selling, general and administrative |
| $ | 696 |
| $ | 770 |
| $ | 1,919 |
| $ | 1,452 |
Research and development |
|
| 31 |
|
| 40 |
|
| 64 |
|
| 98 |
Total |
| $ | 727 |
| $ | 810 |
| $ | 1,983 |
| $ | 1,550 |
As of June 30, 2019, there was approximately $4,120 of total unrecognized compensation costs related to unvested stock option awards, which are expected to be recognized over a weighted-average period of 2.3 years.
16
There were no stock options granted during the three and six months ended June 30, 2019. During the three and six months ended June 30, 2018, the Company granted 2,868 stock options under the Plan at a weighted average exercise price of $1,336.72 per share. There were no stock options exercised during the three and six months ended June 30, 2019 and 2018.
The weighted-average assumptions used in the Black-Scholes option pricing model to estimate the grant date fair value of stock options granted during the three and six months ended June 30, 2018 were as follows:
Risk-free interest rate | 2.85% | ||
Expected term (in years) | 6.25 | ||
Expected dividend yield | 0% | ||
Expected volatility | 121.52% |
The total estimated grant date fair value of stock options granted during the three and six months ended June 30, 2018 was $3,468.
(13) Commitments and Contingencies
Litigation
Fulfillium. On April 20, 2017, Fulfillium, Inc. filed a complaint against ReShape Medical, Inc. (which the Company acquired in October 2017 and which is now a wholly owned subsidiary of the Company) in the U.S. District Court for the District of Delaware, which alleged misappropriation of trade secrets and infringement of two U.S. Patents (“Fulfillium I”). On July 28, 2017, ReShape Medical moved to dismiss both the trade secret claim and certain aspects of the patent infringement claim, and to transfer the litigation to the U.S. District Court for the Central District of California. On October 16, 2017, the Court granted ReShape Medical’s motion to dismiss the trade secret and willful infringement claims, and ordered the case transferred to the U.S. District Court for the Central District of California. Fulfillium twice amended its complaint, narrowing its original trade secret claim and adding further patent infringement claims and additional parties. On June 4, 2018, ReShape Medical filed a motion to dismiss the patent infringement claims for lack of standing, which the Court granted on July 5, 2018. On August 10, 2018, the Court dismissed without prejudice the trade secret claim for lack of subject matter jurisdiction and terminated the case. Fulfillium has appealed these dismissals and ReShape Medical has appealed the grant and denial of certain attorney fee awards. On July 20, 2018, Fulfillium filed a new complaint against ReShape Lifesciences, Inc. (and its wholly owned subsidiary ReShape Medical LLC) in the U.S. District Court for the Central District of California (“Fulfillium II”) reasserting the patent infringement claims asserted in Fulfillium I. On August 15, 2018, Fulfillium amended its complaint in Fulfillium II to reassert the trade secret misappropriation claim asserted in Fulfillium I against ReShape Medical LLC and others. On September 7, 2018, Fulfillium filed a complaint in California state court alleging the same trade secret misappropriation claim asserted in both Fulfillium I and Fulfillium II. On November 7, 2018, the Court dismissed the non-Company parties from Fulfillium II. On April 20, 2018, ReShape Medical filed Inter Partes Review (“IPR”) petitions with the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office (the “PTAB”) to have all claims of both of the originally asserted Fulfillium patents canceled as unpatentable over various combinations of prior art. On November 6, 2018, the PTAB denied those petitions. The parties held a mediation on April 9, 2019, but were unable to resolve the matter. The Company is requiredintends to paycontinue to vigorously defend itself against Fulfillium’s claims. We currently are unable to estimate the losses or range of loss for patient follow up visits onlythese two matters.
Alpha and Iroquois. On July 12, 2018, Alpha Capital Anstalt (“Alpha”) filed a complaint against the Company in the U.S. District Court for the Southern District of New York. In August 2017, Alpha acquired shares of the Company’s series B convertible preferred stock and warrants to purchase shares of the Company’s common stock in an underwritten public offering. Pursuant to the extent they occur. Interms of the event a patient does not attend a follow up visit,series B convertible preferred stock and warrants, the conversion price of the series B convertible preferred stock and exercise price of the warrants was subject to adjustment in the case of, among other things, dilutive issuances of securities by the Company. The complaint alleged breach of contract, claiming that the Company should have adjusted the conversion price of the series B convertible preferred stock and exercise price of the warrants to not less than$420.00 per share, rather than the $1,575.00 per share to which the Company actually adjusted such conversion price and exercise price, in connection with its registered direct offering of series D convertible preferred stock and warrants to purchase common stock that it completed and announced in April 2018. On July 26, 2018, Iroquois Capital Investment Group, LLC and Iroquois Master Fund, Ltd. (“Iroquois”) filed a complaint against the Company in the U.S. District Court for the Southern District of New York, with substantially the same claims and
17
seeking substantially the same relief as Alpha’s complaint described above, except that Iroquois claimed that the conversion price of the series D convertible preferred stock and exercise price of the warrants should have been adjusted to $189.00 per share. Following a mediation held on June 20, 2019, the parties each entered into a mutually agreeable settlement agreement resolving the issues raised in the complaints filed by each Alpha and Iroquois. Pursuant to the settlement agreements, each lawsuit has no financial obligation.been dismissed with prejudice. The terms of the settlement agreements are confidential.
Except as disclosed in the foregoing paragraphs, the Company is also requirednot currently a party to pay for explantsany litigation and the Company is not aware of any pending or revisions, including potential conversions of ReCharge control devices to active devices, should a patient request or be requiredthreatened litigation against it that is reasonably possible to have one duringa material adverse effect on the course ofCompany’s business, operating results or financial condition. The medical device industry in which the clinical trials. The Company has no financial obligation unless an explant, revision or conversionoperates is requested or required. Clinical trial costs are expensedcharacterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as incurred.well as improper hiring practices. As a result, the Company may be involved in various legal proceedings from time to time.
Product Liability Claims
The Company is exposed to product liability claims that are inherent in the testing, production, marketing and sale of medical devices. Management believes any losses that may occur from these matters are adequately covered by insurance, and the ultimate outcome of these matters will not have a material effect on the Company’s financial position or results of operations. The Company is not currently a party to any product liability litigation and is not aware of any pending or threatened product liability litigation that couldis reasonably possible to have a material adverse effect on the Company’s business, operating results or financial condition.
Litigation
On February 28, 2017, the Company received a class action and derivative complaint filed on February 24, 2017 in U. S. District Court for the District of Delaware by Vinh Du, one of the Company’s shareholders. The complaint names as defendants ReShape Lifesciences, the board of directors and four members of our senior management, namely, Scott Youngstrom, Nick Ansari, Peter DeLange and Paul Hickey, and contains a purported class action claim for breach of fiduciary duty against the board of directors and derivative claims for breach of fiduciary duty against the board of directors and unjust enrichment against our senior management. The allegations in the complaint relate to the increase in the number of shares authorized for grant under our Second Amended and Restated 2003 Stock Incentive Plan (the “Plan”), which was approved by our shareholders at the Special Meeting of Shareholders held on December 12, 2016 (the “Special Meeting”), and to our subsequent grant of stock options on February 8, 2017, to the Company’s Directors and senior management to purchase an aggregate of 1,093,450 shares of our common stock (the “Option Grants”). In the complaint, the plaintiff contends that (i) the number of shares authorized for grant under the Plan, as adjusted by the board of directors after the Special Meeting for the subsequent recapitalization of the Company, resulted from an alleged breach of fiduciary duties by the board of directors, and (ii) our senior management was allegedly unjustly enriched by the subsequent Option Grants. The plaintiff seeks relief in the form of an order rescinding the Plan as approved by the shareholders at the Special Meeting, an order cancelling the Option Grants, and an award to plaintiff for his costs, including fees and disbursements of attorneys, experts and accountants. On April 17, 2017, we filed a motion to dismiss the complaint based on the plaintiff’s failure to satisfy Delaware’s demand requirement for a derivative action and failure to state a valid claim. The motion is now fully briefed and the Court will hear oral argument on November 28, 2017. We believe the allegations in the complaint are without merit, and intend to defend the action vigorously.
On April 20, 2017, Fulfillium, Inc., filed a Complaint in the United States District Court for the District of Delaware accusing ReShape Medical, Inc., which the Company acquired on October 2, 2017 and is now a wholly-owned subsidiary of the Company, of trade secret misappropriation under the California Uniform Trade Secrets Act (CA. Civ. Code §3426 et seq.) and/or Delaware law (Code Ann. Title 6 §2001 et seq); and infringement of U.S. Patent Nos. 9,445,930 and 9,456,915. On July 28, 2017, Reshape Medical, Inc. filed a Rule 12(b)(6) motion to dismiss the trade secrets claims as time-barred and/or for failure to state a claim and to dismiss most of the patent infringement claims for failure to state a claim. ReShape Medical, Inc., also filed a motion to transfer the litigation to the United States District Court for the Central District of California. On October 10, 2017, Fulfillium filed a motion seeking leave to amend its complaint to add an investor in ReShape Medical, Inc. as a co-defendant, but did not amend the substantive allegations of its original Complaint that are the basis of the pending motion to dismiss. ReShape Medical, Inc. filed an opposition to the motion for leave to amend on October 24, 2017 and Fulfillium filed its Reply on October 31, 2017. The motions to dismiss and transfer were heard on November 7, 2017, and on November 9, 2017, the Court issued an Order granting-in-part the motion to dismiss, dismissing the trade secret claim and allegations of willful infringement, with leave to amend, and transferring the case to the United States District Court for the Central District of California. The Court did
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not rule on the motion for leave to amend the complaint to add the proposed new party, which remains fully briefed. Management of the Company intends to vigorously defend against the claims and believes the risk of loss remote.
Except as disclosed in the foregoing paragraphs, the Company is not currently a party to any litigation and the Company is not aware of any pending or threatened litigation against it that could have a material adverse effect on the Company’s business, operating results or financial condition. The medical device industry in which the Company operates is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. As a result, the Company may be involved in various legal proceedings from time to time.
(7) Senior Amortizing Convertible Notes
On November 9, 2015, January 11, 2016 and May 2, 2016 the Company issued 7% senior amortizing convertible notes (the “Notes”) with principal amounts of $1.5 million, $11.0 million and $6.25 million. Warrants were also issued in connection with each of the three Notes (the “Note Warrants”). As of December 31, 2016 the Notes were fully amortized, primarily through non-cash conversions of the Notes into shares of common stock. For the nine months ended September 30, 2016, the condensed consolidated statement of operations includes interest expense related to the Notes. See further details regarding the Notes and Note Warrants in footnote 8 to the Company’s Consolidated Financial Statements contained in our Annual Report on Form 10-K for the Year Ended December 31, 2016.
(8) Stock-based Compensation
The fair value method of accounting for share-based payments is applied to all share-based payment awards issued to employees and where appropriate, nonemployees, unless another source of literature applies.
Based on the application of these standards, stock-based compensation expense for stock-based awards under the Company’s Amended and Restated 2003 Stock Incentive Plan (the Plan) and inducement grants for the three and nine months ended September 30, 2017 and 2016, including $138,000 and $4,000 for nonemployees, respectively, was allocated to operating expenses follows:
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| Three Months Ended |
| Nine Months Ended |
| ||||||||
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| September 30, |
| September 30, |
| ||||||||
|
| 2017 |
| 2016 |
| 2017 |
| 2016 |
| ||||
Selling, general and administrative |
| $ | 599,767 |
| $ | 310,133 |
| $ | 3,412,820 |
| $ | 1,731,768 |
|
Research and development |
|
| 17,584 |
|
| 45,203 |
|
| 70,631 |
|
| 470,181 |
|
Total |
| $ | 617,351 |
| $ | 355,336 |
| $ | 3,483,451 |
| $ | 2,201,949 |
|
As of September 30, 2017 there was approximately $5.2 million of total unrecognized compensation costs, related to employee unvested stock option awards, which are expected to be recognized over a weighted-average period of 2.4 years.
The estimated grant-date fair values of the stock options were calculated using the Black-Scholes valuation model, based on the following assumptions for the three and nine months ended September 30, 2017 and 2016:
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| ||||
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| Three Months Ended September 30, |
| Nine Months Ended September 30, |
| ||||
|
| 2017 |
| 2016 |
| 2017 |
| 2016 |
|
Risk-free interest rates |
| 1.88%-1.99% |
| 1.03% |
| 1.88%-2.34% |
| 0.87%–1.64% |
|
Expected life |
| 6.25 years |
| 4.00 years |
| 6.00 years–10.00 years |
| 4.00 years–6.25 years |
|
Expected dividends |
| 0% |
| 0% |
| 0% |
| 0% |
|
Expected volatility |
| 90.93% |
| 96.64% |
| 90.93%–131.24% |
| 88.43%–96.10% |
|
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Option activity under the Plan for the nine months ended September 30, 2017 was as follows:
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| Outstanding Options | |||
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| Shares |
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| Available For |
| Number of |
| Weighted-Average | |
|
| Grant |
| Shares (1) |
| Exercise Price (1) | |
Balance, December 31, 2016 |
| 2,988,243 |
| 19,840 |
| $ | 770.35 |
Shares reserved |
| — |
| — |
|
| — |
Options granted |
| (1,333,450) |
| 1,333,450 |
|
| 6.71 |
Options exercised |
| — |
| — |
|
| — |
Options cancelled |
| 22,124 |
| (22,124) |
|
| 55.73 |
Balance, September 30, 2017 |
| 1,676,917 |
| 1,331,166 |
| $ | 22.63 |
_________________
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(9) Stock Sales
January 2017 Issuance of Common Stock, Convertible Preferred Stock and Warrants
On January 23, 2017, the Company closed an underwritten public offering consisting of units of common stock, convertible preferred stock and warrants to purchase common stock. Gross proceeds of the offering were $19.0 million, prior to deducting underwriting discounts and commissions and offering expenses of $2.5 million.
The offering was comprised of Class A Units, priced at a public offering price of $5.31 per unit, with each unit consisting of one share of common stock and one five-year warrant (each, a "2017 Warrant") to purchase one share of common stock with an exercise price of $5.84 per share, and Class B Units, priced at a public offering price of $1,000 per unit, with each unit comprised of one share of Series A Preferred Stock (the Preferred Stock), which was convertible into 188 shares of common stock, and 2017 Warrants to purchase 188 shares of common stock. The conversion price of the Preferred Stock issued in the transaction as well as the exercise price of the 2017 Warrants are fixed priced and do not contain any variable pricing features nor any price based anti-dilutive features apart from customary adjustments for splits and reverse splits of common stock and both have been recorded within Shareholders’ Equity in the condensed consolidated balance sheet. The Preferred Stock included a beneficial ownership limitation of 4.99%, but had no dividend preference (except to extent dividends are also paid on the common stock), liquidation preference or other preferences over common stock. The securities comprising the units were issued separately in the offering.
A total of 1,218,107 shares of common stock, 12,531 shares of Preferred Stock convertible into 2,359,894 shares of common stock, and 2017 Warrants to purchase 3,577,994 shares of common stock were issued in the offering including the underwriters’ exercise of their over-allotment option to purchase 466,695 shares of common stock and 2017 Warrants to purchase an additional 466,695 shares of common stock.
On January 23 and January 24, 2017 all shares of Preferred Stock issued in conjunction with the offering were converted by their holders into 2,359,894 shares of common stock.
August 2017 Issuance of Convertible Preferred Stock and Warrants
On August 16, 2017, the Company closed a firm commitment underwritten public offering (the “Offering”) of 20,000 units consisting of one share of Series B Convertible Preferred Stock, par value $0.01 per share (the “Series B Preferred Stock”), which is convertible into 435 shares of common stock, par value $0.01 share (the “Common Stock”), at a conversion price of $2.30 per share, and one seven-year warrant to purchase 435 shares of Common Stock at an exercise price of $2.30 per share (the “Warrants”), at a public offering price of $1,000 per unit
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The net proceeds received by the Company from the sale of the units was approximately $18.0 million, after deducting underwriting discounts and offering expenses.
The Series B Preferred Stock was determined to not be mandatorily redeemable under ASC 480. Additionally, the Company identified two embedded features within the Series B Preferred Stock: (1) optional conversion by the holder, and (2) redemption in the event of a fundamental change and the Company determined that neither of these embedded features required bifurcation under ASC 815. Since the Series B Preferred Stock is only redeemable in an ordinary liquidation, upon the occurrence of a fundamental transaction which is solely within the Company’s control, or in circumstances when all common shareholders are entitled to receive the same form of consideration, the Series B Preferred Stock is presented within permanent equity.
The warrants issued with the Series B Preferred Stock were also classified in stockholders’ equity as they are both indexed to the Company’s own stock and meet the scope exception in ASC 815-10-15-74(a) and, accordingly, do not require derivative liability accounting pursuant to ASC 815.
Prior to the closing and subsequent to the Offering, certain purchasers of the units sold in the Offering notified the Company of their election to convert the shares of Series B Preferred Stock underlying such units into shares of Common Stock. As of September 30, 2017, 8,997 of the 20,000 shares of the Series B Preferred Stock issued in the offering had been converted into 3,913,695 shares of Common Stock.
On August 16, 2017, the Company also issued warrants to purchase an aggregate of 2,575,000 shares of Common Stock to certain parties (each, a “Holder”) to the Securities Purchase Agreement (as amended, the “Purchase Agreement”), dated November 4, 2015, between the Company and the other parties named therein, as consideration for the waiver by each of the Holders of their right to participate in future securities offerings by the Company, which rights were granted pursuant to the Purchase Agreement. These warrants are in substantially the same form, and on the same terms as, the Warrants issued pursuant to the Offering. Because the Company received no additional consideration or future rights related to the warrants issued to the Holders, the Black Scholes value of the warrants was recorded as $4.4 million of expense as of the August 16, 2017 issuance date. The Black Scholes value was estimated using a risk-free interest rate of 2.03%, an expected life of 7.0 years, expected dividends of zero and expected volatility of 112.03%.
(10) Warrants
During the nine months ended September 30, 2017, common stock warrants for 599,670 shares of common stock were exercised by warrant holders with proceeds to the Company of $3.3 million.
Stock warrant activity for the nine months ended September 30, 2017 is as follows:
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| Weighted | |
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| Average | |
|
| Common |
| Exercise | |
|
| Shares |
| Price | |
Balance, December 31, 2016 |
| 55,049 |
| $ | 238.90 |
Granted (1) |
| 14,852,994 |
|
| 3.15 |
Exercised |
| (599,670) |
|
| 5.56 |
Cancelled |
| (36) |
|
| 238.90 |
Balance, September 30, 2017 |
| 14,308,337 |
| $ | 3.51 |
_______________
|
|
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(11) Subsequent Events
Acquisition of ReShape Medical, Inc.
On October 2, 2017 the Company acquired ReShape Medical, Inc., a privately-held medical technology company that develops, manufactures and markets the ReShape® Dual Weight Loss Balloon, an FDA and CE marked approved, minimally invasive intragastric balloon designed to treat obesity patients with a body mass index (BMI) between 30 and 40, with one or more related comorbid conditions.
Under the terms of the agreement, the consideration paid by the Company for ReShape Medical consisted of 2,356,729 shares of common stock, 187,772 shares of series C convertible preferred stock (which will be convertible into 18,777,200 shares of common stock upon the receipt of the required approval of the Company’s stockholders under NASDAQ rules), and approximately $5.0 million in cash, which amount was immediately used to pay ReShape Medical’s outstanding senior secured indebtedness and certain transaction expenses of ReShape Medical. The Company agreed to hold a special meeting of its stockholders by December 31, 2017 to seek the required approval of the conversion of the series C convertible preferred stock into shares of common stock.
The Company expects that the ReShape Medical acquisition will be accounted for as a business combination and the Company will record the assets and liabilities acquired at their respective fair values during the fourth quarter of 2017.
Name Change of EnteroMedics Inc. to ReShape Lifesciences Inc.
On October 23, 2017, the Company announced that it filed a Certificate of Amendment to its Certificate of Incorporation with the Secretary of State of the State of Delaware to amend Article I of the Company’s Certificate of Incorporation to change the name of the corporation to “ReShape Lifesciences Inc.” effective on October 23, 2017. In addition, in connection with the name change, the Company’s ticker symbol was changed to “RSLS” which became effective at the start of trading on October 23, 2017, and the Company’s common stock will continue to trade on The NASDAQ Capital Market.
Special Meeting of Shareholders on October 25, 2017
At a Special Meeting of Shareholders on October 25, 2017, the Company’s shareholders approved the following proposals set forth in the Company’s Definitive Proxy Statement on Schedule 14A, which was filed with Securities and Exchange Commission and mailed to the Company’s stockholders on or about October 6, 2017:
Proposal 1: Approval of the conversion of 1,000,181 shares of the Company’s conditional convertible preferred stock issued to the former equity holders of BarioSurg, Inc. (“BarioSurg”) in connection with the Company’s May 22, 2017 acquisition of BarioSurg into 5,000,905 shares of the Company’s common stock.
Proposal 2: Approval of the issuance of 916,834 shares of the Company’s common stock upon the exercise of outstanding warrants issued to certain parties (each, a "Holder") to the Securities Purchase Agreement, dated November 4, 2015, between the Company and the other parties named therein, as consideration for the waiver by each of the Holders of their right to participate in future securities offerings by the Company.
Proposal 3: Approval of an amendment to the Company’s Sixth Amended and Restated Certificate of Incorporation to reduce the number of authorized shares of common stock from 300,000,000 to 275,000,000.
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ITEM 2. MANAGEMENT’SMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with the condensed consolidated financial statements and notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q.
Except for the historical information contained herein, the matters discussed in this “Management’s"Management's Discussion and Analysis of Financial Condition and Results of Operations,”" are forward-looking statements that involve risks and uncertainties. In some cases, these statements may be identified by terminology such as “may,” “will,” “should,” “expects,” “could,” “intends,” “might,” “plans,” “anticipates,” “believes,” “estimates,” “predicts,” “potential,”"may," "will," "should," "expects," "could," "intends," "might," "plans," "anticipates," "believes," "estimates," "predicts," "potential," or “continue,”"continue," or the negative of such terms and other comparable terminology. These statements involve known and unknown risks and uncertainties that may cause our results, level of activity, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Factors that may cause or contribute to such differences include, among others, those discussed in the updated “Risk Factors”"Risk Factors" section attached as Exhibit 99.3 toincluded in Item 1A of our CurrentAnnual Report on Form 8-K10-K filed on July 26, 2017.May 16, 2019.
Except as may be required by law, we undertake no obligation to update any forward-looking statement to reflect events after the date of this report.
Overview
We are a medical device company focused on the development and commercializationdeveloper of minimally invasive medical devices that advance bariatric surgery to treat obesity and metabolic diseasesdiseases. Our current portfolio includes the LAP-BAND® Adjustable Gastric Banding System and gastrointestinal disorders.
The vBlocthe ReShape Vest®TMSystem, our initial, an investigational device, to help treat more patients with obesity. There has been no revenue recorded for the ReShape Vest as the product is a U.S. Food and Drug Administration (FDA)-approved pacemaker-like device that delivers vBloc® Neurometabolic Therapy (vBloc Therapy) to help patients feel full and eat less by intermittently blocking hunger signals on the vagus nerve. Our therapy limits the expansion of the stomach, helps control hunger sensations between meals, reduces the frequency and intensity of stomach contractions and produces a feeling of early and prolonged fullness. We believe the vBloc System offers obese patients a minimally-invasive treatment that can result in significant, durable and sustained weight loss. We believe that our vBloc System allows bariatric surgeons to offer a new option to obese patients who are concerned about the risks and complications associated with currently available anatomy-altering, restrictive or malabsorptive surgical procedures.
We have a limited operating history and on January 14, 2015 received FDA approval to sell the vBloc Systemstill in the United States. In addition, we have regulatory approval to sell the vBloc System in the European Economic Area and other countries that recognize the European CE Mark and do not have any other source of revenue. We were incorporated in Minnesota on December 19, 2002 and later reincorporated in Delaware on July 22, 2004. Prior to October 23, 2017, the Company was known as EnteroMedics Inc. We have devoted substantially all of our resources to the development and commercialization of the vBloc System, which was formerly known as the Maestro or vBloc Rechargeable System.
On May 22, 2017, we acquired the Gastric Vest System™ throughstage. Following our acquisition of BarioSurg.the Lap-Band product line in December 2018, we are no longer actively marketing the ReShape vBloc product.
Results of Operations
Continuing Operations
Revenue. Revenue for the three and six months ended June 30, 2019 of $4.4 million and $7.5 million, respectively, consisted of sales of our Lap-Band product which we acquired in December 2018. Revenues in the current quarter increased $1.3 million over the first three months of 2019, which was primarily due to revenue growth of $0.9 million in the U.S. over the previous quarter. In addition, as a result of our obtaining all distribution rights for the Lap-Band product in April 2019, we had $0.4 million of revenues in Australia. For the three and six months ended June 30, 2018, revenue of $0.1 million in each period was comprised of sales of our ReShape vBloc product.
Gross profit. Gross profit in the second quarter and first half of 2019 of $2.9 million and $5.1 million, respectively, reflects cost of sales associated with the established Lap-Band product line. Gross profit as a percentage of total revenue for the three and six months ended June 30, 2019 was 64 percent and 68 percent, respectively, as compared with 73 percent for the first three months of 2019. The Gastric Vest System is an investigational, minimally invasive, laparoscopically implanted medical device being studied for weight losslower gross profit rates in obesethe second quarter and morbidly obese patients. The Gastric Vest wraps aroundfirst half of 2019 are primarily the result of sales during the second quarter to a plicated stomach, emulating the effect of conventional weight-loss surgery, and is intended to enable gastric volume reduction without permanently changing patient anatomy. The acquisition was completed under the terms of a merger agreement pursuant to which BarioSurg became a wholly-owned subsidiary of our company. The aggregate merger consideration we paidApollo Endosurgery, Inc. (“Apollo”). Pursuant to a distribution agreement, Apollo serves as the Company’s distributor of Lap-Band product in certain geographical areas outside the U.S. for alla period of up to one year from the acquisition date of the outstanding sharesLap-Band product line. Gross profit on sales of capital stockthe ReShape vBloc product in the second quarter and outstanding optionsfirst half of BarioSurg was: (i) 1.382018 was $0.01 million sharesin both periods.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $6.8 million for the three months ended June 30, 2019 as compared with $5.4 million for the three months ended March 31, 2019 and $4.3 million for the three months ended June 30, 2018. For the six months ended June 30, 2019 and 2018, selling general and administrative expenses were $12.2 million and $10.7 million, respectively. Selling, general and administrative expenses in the second quarter and first half of 2019 include $0.9 million of severance costs and $0.5 million of one-time litigation related expenses. The remainder of the increase in 2019 over the same periods in 2018 is primarily the result of an increase in our common stock, (ii) 1.0 million shares of our newly created conditional convertible preferred stock, which shares will convert into 5.0 million shares of our common stock subjectselling costs due to the increase in sales personnel and contingent upon the post-closing approval of our stockholders in accordancehigher commissions associated with the NASDAQ Stock Market Rules, and (iii) $2 million in cash. increased Lap-Band revenues.
On October 2, 2017 the Company acquired ReShape Medical, Inc., a privately-held medical technology company that develops, manufactures and markets the ReShape Dual Weight Loss Balloon® (the ReShape Balloon), an FDA and CE marked approved, minimally invasive intragastric balloon designed to treat obesity patients with a body mass index (BMI) between 30 and 40, with one or more related comorbid conditions. The ReShape Balloon received FDA approval on July 28, 2015. Because the closing of this acquisition was after September 30, 2017, the Company’s Consolidated
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Balance Sheets
Research and StatementsDevelopment Expenses. Research and development expenses were $1.0 million for the three months ended June 30, 2019 compared with $2.1 million for the three months ended June 30, 2018. For the six months ended June 30, 2019, research and development expenses were $2.0. million compared with $4.6 million for the six months ended June 30, 2018. During the 2019, our research and development activities were limited to the continued development of Operationsthe ReShape Vest. Research and development expenses for the 2018 periods included development activities for both the ReShape Vest and ReShape vBloc.
Impairment of Intangible Assets. As a result of an impairment analysis performed during the second quarter of 2019, we recorded an impairment charge of $6.6 million on the indefinite-lived intangible asset recorded in connection with our acquisition of BarioSurg, Inc. (“BarioSurg”) in May 2017. We also assessed the recoverability of finite-lived intangible assets during the second quarter of 2019 and did not identify any impairment as a result the performance of this analysis. Based on an impairment analysis of our goodwill and intangible assets performed during the quarter ended June 30, 2018, we recorded an impairment loss of $14.2 million for the three and six months ended June 30, 2018, eliminating all goodwill balances related to our acquisition of BarioSurg. There were no impairment charges recorded relative to the indefinite and finite-lived intangible assets in 2018. Refer to Note 5 to our Condensed Consolidated Financial statements for additional information about impairment of intangible assets.
Net Interest Expense and Loss on Extinguishment of Debt. We had net noncash interest expense of $0.2 million and $0.3 million for the three months and six months ended June 30, 2019. During the second quarter and first half of 2019, accretion of interest expense on the net present value of the asset purchase consideration payable and the discount and deferred financing costs on the convertible subordinated debentures totaled $0.7 million and $0.9 million, respectively. This noncash interest expense was reduced by $0.5 million for the write-off of an embedded derivative liability recorded for the conversion features of the debentures that were eliminated as a result of the repayment of the debentures prior to their maturity date. In connection with the early repayment of the debentures, we recorded a loss on extinguishment of debt of $0.1 million, which consisted of the unamortized debt discount and deferred financing costs. Refer to Note 6 to our Condensed Consolidated Financial statements for additional information about the asset purchase consideration payable and the convertible subordinated debentures.
Warrants Expense. Warrant expense for the three and six months ended June 30, 2019 includes noncash expense of $8.3 million for the value of variable price features included with this Quarterly Report on Form 10-Qthe warrants and common stock issued in connection with our equity financing completed in June 2019 in excess of the proceeds received. This noncash expense was reduced by $4.2 million for the decrease in fair value of the warrant liability between the issuance date and June 30, 2019. In addition, during the six months ended June 30, 2019, we recorded warrant expense of $0.1 million for the change in fair value of certain warrants held by certain institutional investors for which the exercise price was reduced in connection with the sale of convertible subordinated debentures to those investors. Warrant expense of $0.1 million for the three and six months ended June 30, 2018 is primarily related to the change in fair value of certain warrants held by an institutional investor for which the exercise price was reduced as an inducement for the investor to exercise the warrants.
Other, Net. Other, net for the three and six months ended June 30, 2019 includes $0.7 million of transaction costs required to be expensed as a result of the liability treatment for the warrants issued in connection with our June equity financing. See Note 8 to our Condensed Consolidated Financial statements for additional information about our June equity financing.
Income tax benefit. The income tax benefit of $0.6 million for the three and six months ended June 30, 2019 is due to a reduction in the deferred tax liability associated with an indefinite-lived intangible asset, for which we recorded an impairment charge of $6.6 million during the three months ended June 30, 2019. The income tax benefit is net of an increase to the deferred tax valuation allowance of $1.1 million for the portion of the deferred tax liability reversal that had been netted with the deferred tax asset associated with U.S. federal net operating loss carryforwards that do not reflectexpire. The income tax benefit recorded for the three months and six ended June 30, 2018 of $1.2 million and $2.6 million, respectively, reflects the tax impact of the net operating loss in the period which have an indefinite carryover
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period. A portion of these net operating losses were supported by expected taxable income from the reversal of indefinite-lived intangibles, such that they are more likely than not to be realized.
Discontinued Operations
Loss from discontinued operations for the three and six months ended June 30, 2018 of $15.9 million and $19.8 million, respectively, reflects the activities of our Reshape Balloon product line, which we sold in December 2018 in connection with our acquisition of the Lap-Band product line assets. The loss for the quarter and year to date periods includes an impairment charge of $13.2 million for the full write-down of the goodwill recorded in connection with our acquisition of ReShape Medical.
Under the terms of the merger agreement, the consideration paid by the Company for ReShape Medical, consisted of 2,356,729 shares of common stock, 187,772 shares of series C convertible preferred stock (which will be convertible into 18,777,200 shares of common stock upon the receipt of the required approval of the Company’s stockholders under NASDAQ rules), and approximately $5.0 million in cash, which amountInc. There was immediately used to pay ReShape Medical’s outstanding senior secured indebtedness and certain transaction expenses of ReShape Medical. The Company agreed to hold a special meeting of its stockholders by December 31, 2017 to seek the required approval of the conversion of the series C convertible preferred stock into shares of common stock.
The Company’s products require approval from the U.S. Food and Drug Administration (FDA)no income tax expense or corresponding foreign regulatory agencies prior to commercial sales. The Company received FDA approval on January 14, 2015 for vBloc Therapy, delivered via the vBloc System, and has begun a controlled commercial launch at select surgical centers in the United States. The vBloc System has also received CE Mark and was previously listed on the Australian Register of Therapeutic Goods (ARTG).
We received FDA approval on January 14, 2015 for vBloc Therapy, delivered via the vBloc System, for the treatment of adult patients with obesity who have a Body Mass Index (BMI) of at least 40 to 45 kg/m2, or a BMI of at least 35 to 39.9 kg/m2 with a related health condition such as high blood pressure or high cholesterol levels, and who have tried to lose weight in a supervised weight management program and failed within the past five years. In 2015 we began a controlled commercial launch at select surgical centers in the United States and had our first commercial sales. During 2015, we initiated a controlled expansion of our commercial operations and started the process of building a sales force. In January 2016, we hired new executives to oversee this expansion. Our direct sales force is supported by field clinical engineers who provide training, technical and other support services to our customers. Throughout 2016, our sales force called directly on key opinion leaders and bariatric surgeons at commercially-driven surgical centers that met our certification criteria. Additionally, in 2016, through a distribution agreement with Academy Medical, LLC, U.S. Department of Veterans Affairs (VA) medical facilities now offer the vBloc System as a treatment option to veterans using their veteran healthcare benefits. We plan to build on these efforts in 2017 with self-pay and veteran patient focused direct-to-patient marketing, key opinion leader and center specific partnering—all of this in conjunction with a multi-faceted reimbursement strategy. Our vBloc Therapy is a covered benefit for over 21discontinued operations.
Liquidity and Capital Resources
As of June 30, 2019, we had $4.4 million U.S. veterans. The VA estimates that 78% of U.S. veterans are overweight or obesecash and nearly 25% of VA patients have diabetes.
To date, we have relied on, and anticipate that we will continuecash equivalents to rely on, third-party manufacturers and suppliers for the production of the vBloc System.
In 2016, we sold 62 vBloc units for $787,000 in revenue, and in 2015 we sold 24 units for $292,000 in revenue. We have incurred and expect to continue to incur significant sales and marketing expenses prior to recording sufficient revenue to offset these expenses. Additionally, our selling, general and administrative expenses have increased since we commenced commercial operations, and we expect that they will continue to increase as we continue to build the infrastructure necessary to support our expanding commercial sales, operate as a public company and develop our intellectual property portfolio. For these reasons, we expect to continue to incur operating losses for the next several years.fund operations. We have financed our operations to date principally through the sale of equity securities and debt financing and interest earned on cash investments.
Our goal for the vBloc System remains broad coverage and reimbursement for vBloc Therapy. We believe that the most significant barrier to adoption for patients who want vBloc Therapy has been cost and lack of payer coverage. In June 2017, we launched our vBloc Now program. The vBloc Now program provides qualified patients battling obesity the opportunity to receive vBloc Therapy, including the device, procedure, and vBloc Achieve follow up program, at an affordable price in exchange for sharing detailed health data with ReShape Lifesciences. The program is available for a limited time, will reduce patient total out-of-pocket costs, and compete with leading covered bariatric surgery procedures as well as other low-cost weight loss devices.
In addition, the vBloc Now program provides us with additional commercial data concerning vBloc Therapy in order to enhance our case with third-party payers that the vBloc System can produce a clinically meaningful level of weight loss while also providing a positive impact on diabetes and other comorbidities in certain patients. While we do not expect to recognize any revenues in conjunction with the vBloc Now program, the Company anticipates that vBloc
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Now program expenses, which are included in selling, general and administrative expenses, will be offset by a reduction in marketing and advertising expenses and will not increase the Company’s overall operating expenses.
Financial Overview
Sales Revenue
We received FDA approval on January 14, 2015 for vBloc Therapy, delivered via the vBloc System, and began a controlled commercial launch at select surgical centers in the United States. We had our first commercial sales within the United States in 2015 and we recognized $292,000 in revenue. During the year ended December 31, 2016, recognized 787,000 in revenue. We have not generated revenue from commercial sales outside of the United States since 2012.
Any revenue from initial sales of a new product in the United States or internationally is difficult to predict and in any event will only modestly reduce our continued losses resulting from our research and development and other activities.
Service Revenue
During the 2017 third quarter, the Company provided certain custom development services based on its intellectual property portfolio that had been requested and contracted for by a third party.
Selling, General and Administrative Expenses
Our selling, general and administrative expenses consist primarily of compensation for executive, finance, market development and administrative personnel, including stock-based compensation. Other significant expenses include professional services and consulting fees, costs associated with attending medical conferences, other professional fees for legal services, including legal services associated with our efforts to obtain and maintain broad protection for the intellectual property related to our products, and accounting services, cash management fees and travel expenses.
Also included are the costs of promotional units periodically provided to select customers at no charge in order to introduce them to our product and to enhance our ability to collect commercial data of vBloc Therapy.
Research and Development Expenses
Our research and development expenses primarily consist of engineering, product development, quality assurance and clinical and regulatory expenses, incurred in the development of our vBloc Rechargeable System. Research and development expenses also include employee compensation, including stock-based compensation, consulting services, outside services, materials, clinical trial expenses, including supplies, devices, explants and revisions, depreciation and travel. We expense research and development costs as they are incurred.
Results of Operations
Comparison of the Three Months Ended September 30, 2017 and 2016
Sales Revenue. Sales were $110,000 for the three months ended September 30, 2017 compared with $297,000 for the third quarter of 2016. Unit sales for the third quarter of 2017 were 8 units compared to 22 units in the third quarter of 2016. The reduction in sales revenue was primarily due to the second quarter 2017 introduction of the vBloc Now program, under which qualified patients receive vBloc Therapy at a significantly reduced price and no revenue is recognized from units delivered under the program.
Service Revenue. During the 2017 third quarter, the Company provided certain custom development services based on its intellectual property portfolio that had been requested and contracted for by a third party.
Cost of Revenue. Cost of revenue was $215,000 for the three months ended September 30, 2017, compared to $147,000 for the three months ended September 30, 2016. The increase of $68,000 was due to the labor costs associated with custom development service revenue and was partially offset by the decline in vBloc unit sales. The Company’s
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gross margin percentage declined to 40.4% for the three months ended September 30, 2017 from 50.6% in the prior year period due to the lower margins earned on services revenue than on vBloc unit sales.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $4.6 million for the three months ended September 30, 2017 compared with $3.4 million and for the three months ended September 30, 2016. The $1.2 million or 36.7% increase was driven by a $1.0 million increase in payroll-related expenses, which included approximately $290,000 in non-cash stock compensation expense, a $492,000 increase in acquisition expenses incurred with the May 22, 2017 acquisition of BarioSurg, Inc. and the October 2, 2017 acquisition of ReShape Medical, a $245,000 increase in expenses related to 21 vBloc units implanted during the quarter as part of the vBloc Now program and an increase $172,000 in other professional fees. These expense increases were partially offset by a $403,000 decrease in advertising and marketing expenses and a $366,000 decrease in executive severance expenses
Research and Development Expenses. Research and development expenses declined to $1.1 million for the three months ended September 30, 2017 from $1.3 million for the three months ended September 30, 2016. The decrease of $144,000, or 11.5%, was primarily due to a decline of $322,000 in professional services and was partially offset by an increase in payroll-related expenses of approximately $119,000 (net of a decrease of $28,000 for non-cash stock based compensation) and an increase in supplies expense of $25,000.
Interest Expense. Interest expense was zero for the three months ended September 30, 2017, compared to $1.4 million for the three months ended September 30, 2016. Interest expense for the third quarter of 2016 included interest related to the then outstanding 7% senior amortizing convertible notes (the Notes) with original principal amounts of $1.5 million, $11.0 million and $6.25 million, respectively, and issuance dates of November 9, 2015, January 11, and May 2, 2016, respectively. As of December 31, 2016 the Notes were fully amortized.
Change in Value of Convertible Notes Payable. Since the Notes were fully amortized as of December 31, 2016, there was no valuation change to be recognized in the condensed consolidated statements of operations for the three months ended September 30, 2017. For the three months ended September 30, 2016 the value of the liability increased $909,000 based on the then outstanding Notes’ fair market value calculated using a Binomial Lattice model.
Change in Value of Warrant Liability. The value of the common stock warrant liability for our Series A Warrants decreased $5,000 during the three months ended September 30, 2017, resulting from the marking to market of the Series A Warrants that remain outstanding. The value of the common stock warrant liability for our Series A and Note Warrants decreased $242,000 during the three months ended September 30, 2016. The fair market value of the warrant liability is calculated using the Black-Scholes valuation model, and is primarily driven by the reduction in the Company’s stock price from $0.03 at December 31, 2015 to $0.002 at September 30, 2016.
Comparison of the Nine Months Ended September 30, 2017 and 2016
Sales Revenues. Sales revenues were $243,000 for the nine months ended September 30, 2017 compared with $645,000 for the nine months ended September 30, 2016. Unit sales for the nine months ended September 30, 2017 were 51 units compared to 29 units for the nine months ended September 30, 2016. The reduction in sales revenue was primarily due to the second quarter 2017 introduction of the vBloc Now program.
Service Revenue. During the 2017 third quarter, the Company provided certain custom development services based on its intellectual property portfolio that had been requested and contracted for by a third party.
Cost of Revenues. Cost of revenues were $299,000 for the nine months ended September 30, 2017, compared to $342,000 cost of goods sold for the nine months ended September 30, 2017. The decline was a result of decreased unit sales of vBloc, but was partially offset by labor costs related to custom development service revenues. The Company’s gross margin percentage declined to 39.5% for the nine months ended September 30, 2017 from 46.9% due to both a reduction in average sales price of vBloc units as well as lower margins earned on services revenues.
Selling, General and Administrative Expenses. Selling, general and administrative expenses were $16.1 million for the nine months ended September 30, 2017, compared to $15.1 million for the nine months ended September 30, 2016. The decrease of $1.0 million, or 6.6%, from the prior year period was primarily due to an increase of $1.3 million for payroll-related expenses, which includes an increase of approximately $1.7 million for non-cash stock compensation, a
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$728,000 increase from acquisition expenses incurred with the May 22, 2017 acquisition of BarioSurg, Inc. and the October 2, 2017 acquisition of ReShape Medical, a $652,000 increase in expenses related to 55 vBloc units implanted during the second and third quarters as part of the vBloc Now program. These expense increases were partially offset by lower advertising and marketing expenses of $1.3 million and lower executive severance expenses of $366,000.
Research and Development Expenses. Research and development expenses were $3.6 million for the nine months ended September 30, 2017, compared to $3.9 million for the nine months ended September 30, 2016. The decrease of $293,000, or 7.6%, was primarily due to a decrease of $483,000 in payroll-related expenses and a decrease of $22,000 in professional services expenses, partially offset by an increase in supply expenses of $119,000. The decrease of $483,000 in payroll-related expenses includes decreases of $400,000 for non-cash stock compensation expense.
Interest Expense. Interest expense was zero for the nine months ended September 30, 2017, compared to $3.4 for the nine months ended September 30, 2016. The decrease of $3.4 million is due to the Notes being fully amortized as of December 31, 2016. Interest expense for the first nine months of 2016 included interest related to the then outstanding Notes with original principal amounts of $1.5 million, $11.0 million and $6.25 million, respectively, and issuance dates of November 9, 2015, January 11, 2016 and May 2, 2016, respectively. As of December 31, 2016 the Notes were fully amortized.
Change in Value of Convertible Notes Payable. Since the convertible notes were fully amortized as of December 31, 2016, there was no valuation change to be recognized in the condensed consolidated statements of operations for the nine months ended September 30, 2017. For the nine months ended September 30, 2016 the value of the liability increased $200,000 based on the then outstanding Notes’ fair market value calculated using a Binomial Lattice model.
Change in Value of Warrant Liability. The value of the common stock warrant liability for our Series A Warrants and Note Warrants increased $283,000 during the nine months ended September 30, 2017, primarily resulting of marking to market the Series A Warrants and the Note Warrants for 48,272 common shares as of the date of their exercise. The value of the common stock warrant liability for our Series A and Note Warrants decreased $3.3 million during the nine months ended September 30, 2016. The fair market value of the warrant liability is calculated using the Black-Scholes valuation model, and is primarily driven by the reduction in the Company’s stock price from $0.03 at December 31, 2015 to $0.002 at September 30, 2016.
Liquidity and Capital Resources
As of September 30, 2017, we had $23.4 million in cash bank deposits. While we had no short-term money market funds or other investments at September 30, 2017, we periodically invest in short-term money market funds that are not considered to be bank deposits and are not insured or guaranteed by the Federal Deposit Insurance Company or other government agency. These money market funds seek to preserve the value of the investment at $1.00 per share; however, it is possible to lose money investing in these funds. Periodically, we invest cash in excess of immediate requirements in accordance with our investment policy, primarily with a view to liquidity and capital preservation. At times, such deposits may be in excess of insured limits. We have not experienced any losses on our deposits of cash and cash equivalents.
We have financed our operations to date principally through the sale of equity securities, debt financing and interest earned on investments. On January 23, 2017, we received $19.0 million in gross proceeds, prior to deducting offering expenses of $2.5 million, at the closing of an underwritten public offering of units in order to fund our future operations. On August 16, 2017, the Company closed an underwritten public offering consisting of units of Series B Convertible Preferred Stock and warrants to purchase common stock. Gross proceeds of the offering were $20.0 million, prior to deducting underwriting discounts and commissions and offering expenses of approximately $2.0 million. Both public offerings were undertaken to fund future operations and acquistions.
In addition during the nine months ended September 30, 2017, the Company collected proceeds of $3.3 million from the exercise of common stock warrants for 599,670 shares of common stock.
financing. Our anticipated operations include plans to (i) continue to integrate the sales and operations of the Company with the newly acquired ReShape MedicalLap-Band product line in order to expand sales of both the ReShape Balloondomestically and vBlocinternationally as well as to obtain cost savings synergies, (ii) expand the controlled commercial launch of vBloc Therapy, delivered via the vBloc System, (iii) continue development of the GastricReShape Vest, (iv)(iii) seek opportunities to leverage the Company’sour intellectual property
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portfolio and custom development services to provide third party sales and licensing opportunities, and (v)(iv) explore and capitalize on synergistic opportunities to expand our portfolio and offer future minimally invasive treatments and therapies in the obesity continuum of care. We believeThe Company believes that we haveit has the flexibility to manage the growth of its expenditures and operations depending on the amount of available cash flows, which could include reducing expenditures for marketing, clinical and product development activities. However, the Company will ultimately need to achieve sufficient revenues from product sales and obtain additional debt or equity financing to support its operations.
Management is currently pursuing various funding options, including seeking additional equity or debt financing as well as a strategic merger or other transactionstransaction to obtain additional funding or expand itsto support the expansion of Lap-Band product linesales and to continue the development of, and to successfully commercialize, the ReShape Balloon, the vBloc System and the Gastric Vest. While the acquisition of ReShape MedicalLap-Band product line does provide incremental revenues and cash flows to the Company, the cost to further develop and commercializesupport the clinical trials of the ReShape BalloonVest is expected to significantly exceed revenuesinternally generated cash flows for the foreseeable future. While there can be no assurance that the Company will be successful in its efforts, the Company has a long history of raising equity financing to fund its development activities. Should the Company be unable to obtain adequate financing in the near term, the Company’s business, result of operations, liquidity and financial condition would be materially and negatively affected, and the Company would be unable to continue as a going concern. Additionally, there can be no assurance that, assuming the Company is able to strengthen its cash position, it will achieve sufficient revenue or profitable operations to continue as a going concern.
Senior Amortizing Convertible Notes
On November 9, 2015, January 11, 2016 and May 2, 2016 the Company issued Notes with principal amounts of $1.5 million, $11.0 million and $6.25 million. The Note Warrants were issued in connection with each of the three Notes. As of December 31, 2016 the Notes were fully amortized, primarily through non-cash conversions of the Notes into shares of common stock. For the nine months ended September 30, 2016, the condensed consolidated statement of operations includes interest expense related to the Notes. See further details regarding the Notes and the Note Warrants in footnote 8 to the Company’s consolidated financial statements contained in our Annual Report on Form 10-K for the Year Ended December 31, 2016, which are incorporated herein by reference.
Net Cash Used in Operating Activities
- Continuing Operations
Net cash used in operating activities from continuing operations was $15.7$8.6 million and $17.1$10.9 million for the ninesix months ended SeptemberJune 30, 20172019 and 2016,2018, respectively. The decrease of $1.4 million was primarily due to reductions in charges related to valuation of warrants offset by increased uses of cash for working capital. Net cash used in operating activities from continuing operations was primarily reflects the result of the loss from continuing operations in each year net loss for those periods, lessof noncash expenses for stock-based compensation, depreciationitems and amortization, change in value of convertible notes payable, change in value of warrant liability, and partially offset by changes in operating assets and liabilities.
Net Cash Used in Investing Activities
Net cash used in investing activities was $2.0 million and $12,000 for the nine months ended September 30, 2017 and 2016, respectively. On May 22, 2017 $1.85 million of net cash was used to purchase BarioSurg. Other uses of cash for investing activities for the periods are attributable to the purchase of property and equipment.
Net Cash Provided by Financing Activities
from Continuing Operations
Net cash provided by financing activities was $37.8 million and $16.0of $7.4 million for the ninesix months ended SeptemberJune 30, 2017 and 2016, respectively. Net2019 was primarily related to the $7.6 million of cash provided byproceeds we received in connection with an equity financing activities forcompleted in June 2019. A portion of the nine months ended September 30, 2017 was due to $39.0 million in grossnet proceeds from the issuance equity securities on January 23, 2017 and August 16, 2017 along with $3.3financing were used to repay the $2.2 million face amount of convertible subordinated debentures that were issued at an original issue discount of 10 percent in proceeds from the exercise of common stock warrants. Partially offsetting these amounts were $4.5 million of expenses related to the equity offerings. For the nine months ended September 30, 2016, $17.25 million of cash provided by financing activities consisted of $11.0 million from the issuance of Notes on January 11, 2016 and $6.25 million from the issuance of notes on May 2, 2016, partially offset by $447,000 of cash payments on the Notes and $727,000 in debt issuance and common stock financing costs.
March 2019.
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Discontinued Operations
Net cash used in operating activities of discontinued operations of $4.9 million for the six months ended June 30, 2018, reflects activities of the ReShape Balloon product line. There were no investing or financing activities related to discontinued operations for the six months ended June 30, 2018.
Operating Capital and Capital Expenditure Requirements
We received FDA approval on January 14, 2015 for vBloc Therapy, delivered via the vBloc System, and began a controlled commercial launch at select bariatric centers of excellence in the United States. We had our first commercial sales within the United States in 2015 and for the years ended December 31, 2015 and 2016, we recognized $292,000 and $787,000 in revenue, respectively. For the nine months ended September 30, 2017, we recognized $493,000 in revenue. We anticipate that we will continue to incur net losses for the next several years as we develop our products, commercialize our vBloc System, develop the corporate infrastructure required to sell our products, operate as a publicly-traded company and pursue additional applications for our technology platform.
We have financed our operations to date principally through the sale of equity securities, debt financing and interest earned on investments. As of December 31, 2016, we had $3.3 million of cash and cash equivalents. On January 23, 2017, we received $19.0 million in gross proceeds, prior to deducting offering expenses of $2.5 million, at the closing of an underwritten public offering of units consisting of common stock, convertible preferred stock and common stock warrants in order to fund our operations. On August 16, 2017, the Company closed an underwritten public offering consisting of units of Series B Convertible Preferred Stock and warrants to purchase common stock. Gross proceeds of the offering were $20.0 million, prior to deducting underwriting discounts and commissions and offering expenses of approximately $2.0 million.
Additionally, during the nine months ended September 30, 2017, common stock warrants for 599,6706 shares of common stock were exercised by warrant holders with proceeds to the Company of $3.3 million (see also Notes 9 and 10 to the condensed consolidated financial statements included with this Quarterly Report on Form 10-Q for the Quarter Ended September 30, 2017).
Our anticipated operations include plans to (i) continue to integrate the sales and operations of the Company with the newly acquired ReShape Medical in order to expand sales of both the ReShape Balloon and vBloc as well as to obtain cost savings synergies,Lap-Band product line; (ii) expand the controlled commercial launch of vBloc Therapy, delivered via the vBloc System, (iii) continue development of the GastricReShape Vest, (iv)(iii) seek opportunities to leverage the Company’s intellectual property portfolio and custom development services to provide third party sales and licensing opportunities, and (v)(iv) explore and capitalize on synergistic opportunities to expand our portfolio and offer future minimally invasive treatments and therapies in the obesity continuum of care. We believeThe Company believes that we haveit has the flexibility to manage the growth of ourits expenditures and operations depending on the amount of available cash flows, which could include reducing expenditures for marketing, clinical and product development activities. However, the Company will ultimately need to achieve sufficient revenues from product sales and obtain additional debtequity or equitydebt financing to support its operations.
Management is currently pursuing various funding options, including seekingObtaining funds through the sale of additional equity financing as well as a strategic, mergerand debt securities or other transactions to obtain additional funding or further expand its product line to continue the development of, and to successfully commercialize, the ReShape Balloon, the vBloc System and the Gastric Vest. While the acquisition of ReShape Medical does provide incremental revenues to the Company, the cost to further develop and commercialize the ReShape Balloon is expected to significantly exceed revenues for the foreseeable future. While there can be no assurance that the Company will be successful in its efforts, the Company has a long history of raising equity financing to fund its development activities. Should the Company be unable to obtain adequate financing in the near term, the Company’s business, result of operations, liquidity and financial condition would be materially and negatively affected, and the Company would be unable to continue as a going concern. Additionally, there can be no assurance that, assuming the Company is able to strengthen its cash position, it will achieve sufficient revenue or profitable operations to continue as a going concern.
Obtaining funds through the warrant holders’ exercise of outstanding common stock warrants or the sale of additional equity and debt securities may result in dilution to our stockholders. If we raise additional funds through the issuance of debt securities, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. The sale of additional equity may require us to obtain approval from our stockholders to increase the number of shares of common stock we have authorized under our certificate of incorporation. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of, delay, or eliminate some or all of, our planned research, development and commercialization activities, which could materially harm our business. In addition, if we raise additional funds through
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collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to products or proprietary technologies, or grant licenses on terms that are not favorable.
Our forecast of the period of time through which our financial resources will be adequate to support our operations, the costs to complete development of products and the cost to commercialize our products are forward-looking statements and involve risks and uncertainties, and actual results could vary materially and negatively as a result of a number of factors, including the factors discussed in in Exhibit 99.3Part I, Item 1A, Risk Factors, of our CurrentAnnual Report on Form 8-K filed10-K. We have based these estimates on July 26, 2017.assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we currently expect.
The Company’s acquisition of the Lap-Band product line provides incremental revenues and cash flows and does not require further product development. In order to continue the development of, and to successfully commercialize the ReShape Vest, the Company’s management is currently pursuing various funding options, including seeking additional equity or debt financing as well as a strategic merger or other transaction to obtain additional funding. The Company has a long history of raising equity financing to fund its development activities; however, there can be no assurance that the Company will continue to be successful in its efforts. Should the Company be unable to obtain adequate financing in the near term, the Company’s business, result of operations, liquidity and financial condition would be materially and negatively affected, and the Company would be unable to continue as a going concern. Additionally, there can be no assurance that, assuming the Company is able to strengthen its cash position, it will achieve sufficient revenue or profitable operations to continue as a going concern. The consolidated financial statements do not include any adjustments that might be necessary if the Company is unable to continue as a going concern.
Because of the numerous risks and uncertainties associated with the development of medical devices, such as our vBloc System,ReShape Vest, we are unable to estimate the exact amounts of capital outlays and operating expenditures necessary to complete the development of the ReShape Vest or other additional products and successfully deliver a commercial product to the market. Our future capital requirements will depend on many factors, including, but not limited to, the following:
· | the cost and timing of establishing sales, marketing and distribution capabilities; |
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· | the cost of establishing clinical and commercial supplies of our |
· | the rate of market acceptance of our |
· | the cost of filing and prosecuting patent applications and defending and enforcing our patent and other intellectual property rights; |
· | the cost of defending, in litigation or otherwise, any claims that we infringe third-party patent or other intellectual property rights; |
· | the effect of competing products and market developments; |
· | the cost of explanting clinical devices; |
· | the terms and timing of any collaborative, licensing or other arrangements that we may establish; |
· | revenue from sales of our established Lap-Band product, any revenue generated by sales of our |
· | the scope, rate of progress, results and cost of our clinical trials and other research and development activities; |
· | the cost and timing of obtaining any further required regulatory approvals; and |
· | the extent to which we invest in products and |
Critical Accounting Policies and Estimates
We prepare our consolidated financial statementsThe Condensed Consolidated Financial Statements have been prepared in accordance with accounting principles generally accepted in the United States. In doing so, we haveStates which require us to make estimates and assumptions that affect ourthe reported amounts of assets and liabilities at the date of the Condensed Consolidated Financial Statements and revenues and expenses as well as related disclosure of contingent assets and liabilities. In many cases, weduring the periods reported. Actual results could reasonably have used differentdiffer from those estimates. Information with respect to our critical accounting policies and estimates. In some cases, changes in the accounting estimates are reasonably likely to occur from period to period. Accordingly, actual results could differ materially from our estimates. To the extent that there are material differences between these estimates and actual results, our financial condition or results of operations will be affected. We base our estimates on past experiences and other assumptions thatwhich we believe are reasonable undercould have the circumstances,most significant effect on our reported results and we evaluate these estimatesrequire subjective or complex judgments by management is contained on an ongoing basis.
Other than as describedpages 37-38 in ImpairmentItem 7, “Management's Discussion and Analysis of Long-Lived Assets, Intangible AssetsFinancial Condition and Goodwill in Note 1 to the condensed consolidated financial statements included in this QuarterlyResults of Operations,” of our Annual Report on Form 10-Q, during10-K for the nineyear ended December 31, 2018. There have been no significant changes from the information discussed therein.
During the six months
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ended SeptemberJune 30, 20172019 there were no material changes to our significant accounting policies which are fully described in Note 2 to our consolidated financial statementsConsolidated Financial Statements included in our Annual Report on Form 10-K for the year ended December 31, 2016.2018.
Off-Balance Sheet Arrangements
As of SeptemberJune 30, 2017,2019, we did not have any off-balance sheet arrangements.
Recent Accounting Pronouncements
In May 2014, FASB issued Revenue from Contracts with Customers, Topic 606 (Accounting Standards Update No. 2014-09 (ASU 2014-09)), which providesSee Note 1 to our Condensed Consolidated Financial Statements for a framework for the recognitiondiscussion of revenue, with the objective that recognized revenues properly reflect amounts an entity is entitled to receive in exchange for goods and services. This guidance will be effective for interim and annual reporting periods beginning after December 15, 2017. The Company intends to use the modified retrospective approach when it adopts the standard as required January 1, 2018. The Company’s accounting for revenue related to vBloc products is not expected to materially change. The implications of the adoption of the new standard related to sales of ReShape Medical’s products are currently being evaluated. Additionally, the new standard will likely require incremental revenue disclosures that may be significant.
In March 2016, FASB issued Improvements to Employee Share-Based Payment Accounting, (Accounting Standards Update No. 2016-09 (ASU 2016-09)), which is intended to simplify several aspects of the accounting for share-based payment transactions, including the income tax consequences, classification of awards as either equity or liabilities, the estimation of forfeitures, shares withheld for taxes and classification of shares withheld for taxes on the statement of cash flows. As part of the adoption of this guidance the Company has elected to account for forfeitures of share-based awards as they occur. The Company prospectively adopted ASU 2016-09 as required on January 1, 2017 and the adoption did not have a material effect on its consolidated financial statements.
In July 2017, FASB issued ASU 2017-11, Earnings Per Share (Topic 260); Distinguishing Liabilities from Equity (Topic 480); Derivatives and Hedging (Topic 815): (Part I) Accounting for Certain Financial Instruments with Down Round Features, (Part II) Replacement of the Indefinite Deferral for Mandatorily Redeemable Financial Instruments of Certain Nonpublic Entities and Certain Mandatorily Redeemable Noncontrolling Interests with a Scope Exception. The amendments in this update are intended to simplify the accounting for certain equity-linked financial instruments and embedded features with down round features that result in the strike price being reduced on the basis of the pricing of future equity offerings. Under the new guidance, a down round feature will no longer need to be considered when determining whether certain financial instruments or embedded features should be classified as liabilities or equity instruments. That is, a down round feature will no longer preclude equity classification when assessing whether an instrument or embedded feature is indexed to an entity's own stock. In addition, the amendments clarify existing disclosure requirements for equity-classified instruments. These amendments are effective for fiscal years, and interim periods within those years, beginning after December 15, 2018, with early adoption permitted. We early adopted the applicable amendments in the third quarter of 2017 on a retrospective basis.
There have been no other significant changes in recent accounting pronouncements during the nine months ended September 30, 2017 as compared to the recent accounting pronouncements described in the Company’s Annual Report on Form 10-K for the year ended December 31, 2016.pronouncements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our exposure to market risk is confined to our cash and cash equivalents. As of September 30, 2017, we had $23.4 million in cash and cash equivalents. The goals of our investment policy are preservation of capital, fulfillment of liquidity needs and fiduciary control of cash and investments. We also seek to maximize income from our investments without assuming significant risk. To achieve our goals, we may maintain a portfolio of cash equivalents and investments in a variety of securities of high credit quality. The securities in our investment portfolio, if any, are not leveraged, are classified as either available for sale or held-to-maturity and are, due to their very short-term nature, subject to minimal interest rate risk. We currently do not hedge interest rate exposure. Because of the short-term maturities of our cash equivalents, we do not believe that an increase in market rates would have any material negative
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impact on the value of our investment portfolio. We have no investments denominated in foreign currencies and therefore our investments are not subject to foreign currency exchange risk.
ITEM 4. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures
Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the Exchange Act), defines the term “disclosure controls and procedures” as those controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under 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 the company’s management, including its principal executive and principal financial officers, or persons performing similar functions, as appropriate to allow timely decisions regarding required disclosure.
Based on their evaluation as of SeptemberJune 30, 2017,2019, our Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) were not effective as of June 30, 2019 for the reasons described below:
Management has determined that the Company has not maintained adequate accounting resources with a sufficient understanding of accounting principles generally accepted in the United States of America (“GAAP”) to ensureallow the Company to identify and properly account for new complex transactions. Management has determined that this represents a material weakness in the Company’s internal control over financial reporting. As a result of this material weakness, management has identified the following additional material weakness in the Company’s internal control over financial reporting:
· | The Company did not design and implement internal controls around research and development expenses paid to a Contract Resource Organization (“CRO”). This material weakness resulted in the Company not identifying that certain research and development expenses paid to the CRO in connection with the clinical trial of the ReShape Vest are required to be capitalized under GAAP and recognized into expense as the value of the capitalized asset is realized. |
Notwithstanding the material weaknesses in our internal control over financial reporting, we have concluded that the consolidated financial statements and other financial information requiredincluded in our annual and quarterly filings fairly present in all material respects our financial condition, results of operations and cash flows as of, and for, the periods presented.
Material Weaknesses Remediation Activities
To remediate the material weaknesses in our internal control over financial reporting described above, we established transactional level controls to be disclosed by usevaluate and monitor the accounting treatment for research and development-related costs. Remediation efforts relating to the adequacy of accounting resources with a sufficient understanding of GAAP are in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reportedprocess, which involve a re-evaluation of our overall staffing levels within the accounting department, evaluating the extent to which additional resources are required and what qualifications such resources must possess, and attracting and hiring those resources. We also plan to re-evaluate the trainings and ongoing professional education that is provided to, and required of, our accounting personnel. Once these processes have been in operation for a sufficient period of time periods specified infor our management to conclude that the SEC’s rulesmaterial weaknesses have been fully remediated and forms.
our internal controls over financial reporting are effective, we will consider these material weaknesses fully addressed.
Changes in Internal Control Over Financial Reporting
Other than changes in internal controls related to goodwill and intangible assets, thereThere were no changes in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended SeptemberJune 30, 20172019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.reporting, other than as described below.
· | Activities pertaining to our remediation efforts of material weaknesses (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act)• |
· | New business processes pertaining to accounting for the lap-band sales and accounts receivable |
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Fulfillium. On February 28,April 20, 2017, Fulfillium, Inc. filed a complaint against ReShape Medical, Inc. (which the Company receivedacquired in October 2017 and which is now a class action and derivative complaint filed on February 24, 2017wholly owned subsidiary of the Company) in U. S.the U.S. District Court for the District of Delaware, by Vinh Du, one of the Company’s shareholders. The complaint names as defendants ReShape Lifesciences, the board of directors and four members of our senior management, namely, Scott Youngstrom, Nick Ansari, Peter DeLange and Paul Hickey, and contains a purported class action claim for breach of fiduciary duty against the board of directors and derivative claims for breach of fiduciary duty against the board of directors and unjust enrichment against our senior management. The allegations in the complaint relate to the increase in the number of shares authorized for grant under our Second Amended and Restated 2003 Stock Incentive Plan (the “Plan”), which was approved by our shareholders at the Special Meeting of Shareholders held on December 12, 2016 (the “Special Meeting”), and to our subsequent grant of stock options on February 8, 2017, to the Company’s Directors and senior management to purchase an aggregate of 1,093,450 shares of our common stock (the “Option Grants”). In the complaint, the plaintiff contends that (i) the number of shares authorized for grant under the Plan, as adjusted by the board of directors after the Special Meeting for the subsequent recapitalization of the Company, resulted from an alleged breach of fiduciary duties by the board of directors, and (ii) our senior management was allegedly unjustly enriched by the subsequent Option Grants. The plaintiff seeks relief in the form of an order rescinding the Plan as approved by the shareholders at the Special Meeting, an order cancelling the Option Grants, and an award to plaintiff for his costs, including fees and disbursements of attorneys, experts and accountants. On April 17, 2017, we filed a motion to dismiss the complaint based on the plaintiff’s failure to satisfy Delaware’s demand requirement for a derivative action and failure to state a valid claim. The motion is now fully briefed and the Court will hear oral argument on November 28, 2017. We believe the allegations in the complaint are without merit, and intend to defend the action vigorously.
On April 20, 2017, Fulfillium, Inc., filed a Complaint in the United States District Court for the District of Delaware accusing ReShape Medical, Inc., which the Company acquired on October 2, 2017 and is now a wholly-owned subsidiary of the Company,misappropriation of trade secret misappropriation under the California Uniform Trade Secrets Act (CA. Civ. Code §3426 et seq.) and/or Delaware law (Code Ann. Title 6 §2001 et seq);secrets and infringement of two U.S. Patent Nos. 9,445,930 and 9,456,915.Patents (“Fulfillium I”). On July 28, 2017, ReshapeReShape Medical Inc. filed a Rule 12(b)(6) motionmoved to dismiss both the trade secrets claims as time-barred and/or for failure to state asecret claim and to dismiss mostcertain aspects of the patent infringement claims for failure to state a claim. ReShape Medical, Inc., also filed a motionclaim, and to transfer the litigation to the United StatesU.S. District Court for the Central District of California. On October 10, 2017, Fulfillium filed a motion seeking leave to amend its complaint to add an investor in ReShape Medical, Inc. as a co-defendant, but did not amend the substantive allegations of its original Complaint that are the basis of the pending motion to dismiss. ReShape Medical, Inc. filed an opposition to the motion for leave to amend on October 24, 2017 and Fulfillium filed its Reply on October 31, 2017. The motions to dismiss and transfer were heard on November 7, 2017, and on November 9,16, 2017, the Court issued an Order granting-in-part thegranted ReShape Medical’s motion to dismiss dismissing the trade secret claim and allegations of willful infringement with leave to amend,claims, and transferringordered the case transferred to the United StatesU.S. District Court for the Central District of California. TheFulfillium twice amended its complaint, narrowing its original trade secret claim and adding further patent infringement claims and additional parties. On June 4, 2018, ReShape Medical filed a motion to dismiss the patent infringement claims for lack of standing, which the Court did not rulegranted on July 5, 2018. On August 10, 2018, the motionCourt dismissed without prejudice the trade secret claim for leavelack of subject matter jurisdiction and terminated the case. Fulfillium has appealed these dismissals and ReShape Medical has appealed the grant and denial of certain attorney fee awards. On July 20, 2018, Fulfillium filed a new complaint against ReShape Lifesciences, Inc. (and its wholly owned subsidiary ReShape Medical LLC) in the U.S. District Court for the Central District of California (“Fulfillium II”) reasserting the patent infringement claims asserted in Fulfillium I. On August 15, 2018, Fulfillium amended its complaint in Fulfillium II to amendreassert the trade secret misappropriation claim asserted in Fulfillium I against ReShape Medical LLC and others. On September 7, 2018, Fulfillium filed a complaint to addin California state court alleging the proposed new party, which remains fully briefed. Managementsame trade secret misappropriation claim asserted in both Fulfillium I and Fulfillium II. On November 7, 2018, the Court dismissed the non-Company parties from Fulfillium II. On April 20, 2018, ReShape Medical filed Inter Partes Review (“IPR”) petitions with the Patent Trial and Appeal Board of the U.S. Patent and Trademark Office (the “PTAB”) to have all claims of both of the originally asserted Fulfillium patents canceled as unpatentable over various combinations of prior art. On November 6, 2018, the PTAB denied those petitions. The parties held a mediation on April 9, 2019, but were unable to resolve the matter. The Company intends to continue to vigorously defend itself against Fulfillium’s claims. We currently are unable to estimate the losses or range of loss for these two matters.
Alpha and Iroquois. On July 12, 2018, Alpha Capital Anstalt (“Alpha”) filed a complaint against the Company in the U.S. District Court for the Southern District of New York. In August 2017, Alpha acquired shares of the Company’s series B convertible preferred stock and warrants to purchase shares of the Company’s common stock in an underwritten public offering. Pursuant to the terms of the series B convertible preferred stock and warrants, the conversion price of the series B convertible preferred stock and exercise price of the warrants was subject to adjustment in the case of, among other things, dilutive issuances of securities by the Company. The complaint alleged breach of contract, claiming that the Company should have adjusted the conversion price of the series B convertible preferred stock and exercise price of the warrants to not less than $420.00 per share, rather than the $1,575.00 per share to which the Company actually adjusted such conversion price and exercise price, in connection with its registered direct offering of series D convertible preferred stock and warrants to purchase common stock that it completed and announced in April 2018. On July 26, 2018, Iroquois Capital Investment Group, LLC and Iroquois Master Fund, Ltd. (“Iroquois”) filed a complaint against the Company in the U.S. District Court for the Southern District of New York, with substantially the same claims and believesseeking substantially the risksame relief as Alpha’s complaint described above, except that Iroquois claimed that the conversion price of loss remote.the series D convertible preferred stock and exercise price of the warrants should have been adjusted to $189.00 per share. Following a mediation held on June 20, 2019, the parties each entered into a mutually agreeable settlement agreement resolving the issues raised in the complaints filed by each Alpha and Iroquois. Pursuant to the settlement agreements, each lawsuit has been dismissed with prejudice. The terms of the settlement agreements are confidential.
Except as disclosed in the foregoing paragraphs, the Company is not currently a party to any litigation and the Company is not aware of any pending or threatened litigation against it that is reasonably possible to have a material adverse effect on the Company’s business, operating results or financial condition. The medical device industry in which the Company operates is characterized by frequent claims and litigation, including claims regarding patent and other intellectual property rights as well as improper hiring practices. As a result, the Company may be involved in various legal proceedings from time to time. Except as disclosed in the foregoing paragraphs, the Company is not currently a party to any litigation and the Company is not aware of any pending or threatened litigation against it that could have a material adverse effect on the Company’s business, operating results or financial condition. The medical device industry in which the Company operates is characterized by frequent claims and litigation, including claims regarding patent and
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other intellectual property rights as well as improper hiring practices. As a result, the Company may be involved in various legal proceedings from time to time.
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Except for the addition of the risk factors shown below, thereThere have been no material changes to the risk factors set forth in Exhibit 99.3Item 1.A Risk Factors of our Current2018 Annual Report on Form 8-K10-K filed on July 26, 2017.May 16, 2019.
Our acquisition of ReShape Medical in October 2017 could adversely affect our operations, financial results and financial condition.
In October 2017, we acquired ReShape Medical, a privately-held medical technology company that develops, manufactures and markets the ReShape® Dual Weight Loss Balloon, an FDA and CE marked approved, minimally invasive intragastric balloon designed to treat obesity patients with a body mass index (BMI) between 30 and 40, with one or more related comorbid conditions. With respect to our acquisition of ReShape Medical and any future acquisitions, we may experience:
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In addition, the FDA has published an announcement to alert health care providers of five reports of unanticipated deaths that occurred within one month of the placement of an intragastric balloon, one of which involved the ReShape Dual Weight Loss Balloon. The announcement indicated that the root cause or incidence of patient death in these cases had not been found and the FDA was not able to definitively attribute the deaths to the balloon devices or their respective insertion procedures. The announcement also indicated that the FDA had received an additional report of a death related to potential complications associated with an esophageal perforation related to the ReShape Dual Weight Loss Balloon. If these adverse events occur more frequently or other serious adverse effects are detected in liquid-filled intragastric balloons, the ReShape Dual Weight Loss Balloon product may be subject to adverse FDA action or additional communications from the FDA, which could harm our business.
We have invested, and expect to continue to invest, significant cash and other resources in connection with our acquisition of ReShape Medical. The consideration we paid to acquire ReShape Medical included $5 million in cash and our efforts to continue the commercialization of the ReShape Dual Weight Loss Balloon will require significant cash expenditures. There can be no assurance that we will be successful in our efforts. Should we be unable to obtain adequate financing or generate sufficient revenue in the future, our business, result of operations, liquidity and financial condition could be materially and adversely harmed.
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If we do not achieve the contemplated benefits of our acquisition of ReShape Medical, our business and financial condition may be materially impaired.
We may not achieve the desired benefits from our acquisition of ReShape Medical. For any of the reasons described above and elsewhere in this report and even if we are able to successfully operate ReShape Medical within our company, we may not be able to realize the revenue and other growth that we anticipate from the acquisition in the time frame that we currently expect, and the costs of achieving these benefits may be higher than what we currently expect, because of a number of risks, including the possibility that the acquisition may not further our business strategy as we expected and risks related to contingent liabilities related to the acquisition such as those related to the FDA’s announcement regarding the unanticipated deaths involving the ReShape Dual Weight Loss Balloon.
As a result of these risks, we may not achieve the anticipated strategic and financial benefits of the ReShape Medical acquisition.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Unregistered Sales of Equity Securities
None.
Uses of Proceeds from Sale of Registered Securities
None.
Purchases of Equity Securities
None.
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
None.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
None.
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31.1** |
| Certification of Chief Executive Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | ||
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| Certification of Chief Financial Officer pursuant to Section 302 of the Sarbanes-Oxley Act of 2002. | |||
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32.1** |
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32.2** |
| Certification of Chief Financial Officer pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. | |||
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*Pursuant to Item 601(b)(2) of Regulation S-K, the schedules to the Merger Agreement (identified therein) have been omitted from this report and will be furnished supplementally to the SEC upon request.
**Filed herewith.
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Pursuant to the requirements of Section 13 or 15(d) 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.
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| Scott P. Youngstrom |
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