| The Company | Note 1 The Company: Background MELA Sciences, Inc. (and its subsidiary) (the
“Company”) is a medical technology company dedicated to developing and commercializing innovative products for the
diagnosis and treatment of serious dermatological disorders. In June 2015 the Company completed the acquisition of the XTRAC excimer
laser and the VTRAC excimer lamp businesses from PhotoMedex, Inc. The XTRAC® and VTRAC® products are FDA cleared devices
for the treatment of psoriasis, vitiligo and other skin disorders. The purchase price was $42,500 plus the assumption of certain
business-related liabilities. Management believes that the cash flow generated by these businesses will be sufficient to finance
our operations, including the continuing commercialization of the MELAFind® system for the foreseeable future. The XTRAC is an ultraviolet light excimer
laser system utilized to treat psoriasis, vitiligo and other skin diseases. The XTRAC received FDA clearance in 2000 and has since
become a widely recognized treatment among dermatologists. The system delivers targeted 308um ultraviolet light to affected areas
of skin, leading to psoriasis clearing and vitiligo repigmentation, following a series of treatments. As of June 30, 2015, there
were 664 XTRAC systems placed in dermatologistsÂ’ offices in the United States. The systems generate recurring revenue whereby,
the XTRAC system is placed in a physicianÂ’s office and revenue is recognized on a per procedure basis. The XTRAC systemÂ’s
use for psoriasis is covered by nearly all major insurance companies, including Medicare. The VTRAC Excimer Lamp system, offered
internationally, provides targeted therapeutic efficacy demonstrated by excimer technology with the simplicity of design and reliability
of a lamp system. In 2014, over 300,000 XTRAC laser treatments were performed on approximately 19,000 patients in the United States. The financial results of the XTRAC and VTRAC
businesses have been included in the results of operations beginning June 23, 2015. The assets of the businesses purchased and
liabilities assumed have been consolidated as of June 23, 2015. (See Note 2 Acquisition To finance the purchase of the XTRAC and VTRAC
businesses, in June 2015 the Company entered into a securities purchase agreement with institutional investors (the “Purchasers”)
in connection with a private placement (the “2015 Financing”). The Company sold $10,000 aggregate principal amount
of Notes bearing interest at 9% per year, with a maturity date of the earlier of 30 days after the Company obtains stockholder
approval of stock issuances under the Debentures and the Warrants or November 30, 2015. The Purchasers of the Notes were issued
Warrants to purchase an aggregate of 3.0 million shares of our common stock, having an exercise price of $0.75 per share. The Company
also issued $32,500 aggregate principal amount of Senior Secured Convertible Debentures (“Debentures”) that, subject
to certain ownership limitations and stockholder approval conditions, will be convertible into 43,333,334 shares of common stock
at an initial conversion price of $0.75 per share. The Debentures bear interest at the rate of 2.25% per year, and, unless previously
converted, will mature on the five-year anniversary of the date of issuance. The CompanyÂ’s obligations under the Notes and
Debentures (collectively, the “Debt Securities”), except for $500 of Debentures, are secured by a first priority lien
on all of the assets, except for a second lien on the intellectual property. Under the terms of the Debentures and the Warrants,
the issuances of shares of the common stock, including the Shares upon conversion of the Debentures and upon exercise of the Warrants,
are subject to (i) the approval by the CompanyÂ’s stockholders of an amendment to our Fifth Amended and Restated Certificate
of Incorporation to increase the number of authorized shares of our common stock and (ii) the approval by the CompanyÂ’s stockholders,
pursuant to NASDAQ Marketplace Rules, of the CompanyÂ’s issuance of up to an aggregate of 62,837,601 shares of the CompanyÂ’s
common stock upon (a) conversion of the Debentures; (b) payment of interest on the Debentures and the Notes; (c) exercise of the
Warrants; and (d) exercise of the Reset Warrants (the “Stockholders Approval Requirements”). Effective upon the date
the Stockholder Approval Requirement is satisfied, of which we provide no assurance, we have also agreed to reprice outstanding
Warrants held by certain investors to reduce the exercise price to $0.75 per share. Liquidity As of June 30, 2015, the Company had an accumulated
deficit of $197,413 and has incurred losses since inception. To date, the Company has dedicated most of its financial resources
to research and development, sales and marketing, and general and administrative expenses. The Company has experienced recurring
losses and negative cash flow from operations. The Company has been dependent on raising capital from the sale of securities in
order to continue to operate and to meet its obligations in the ordinary course of business. Although the Company plans to refinance
the Notes that are scheduled to become due in 2015 with longer term debt, the terms and availability of which the Company cannot
determine at this time. The timing and availability of any such refinancing cannot be assured and will be affected by numerous
factors, many of which are not under our control. There can be no assurance that we will be able to raise additional funding as
may be needed or on terms that are acceptable to the Company. These factors raise substantial doubt about the CompanyÂ’s ability
to continue as a going concern. The Company has not made any adjustments to its consolidated financial statements with respect
to this uncertainty. Basis of Presentation Accounting Principles The accompanying condensed consolidated financial
statements and related notes should be read in conjunction with the financial statements and related notes contained in the CompanyÂ’s
Annual Report on Form 10-K for the fiscal year ended December 31, 2014 (“fiscal 2014”). The unaudited condensed consolidated
financial statements have been prepared in accordance with the rules and regulations of the Securities and Exchange Commission
(“SEC”) related to interim financial statements. As permitted under those rules, certain information and footnote disclosures
normally required or included in financial statements prepared in accordance with accounting principles generally accepted in the
United States (“U.S. GAAP”) have been condensed or omitted. The financial information contained herein is unaudited;
however, management believes all adjustments have been made that are considered necessary to present fairly the results of the
CompanyÂ’s financial position and operating results for the interim periods. All such adjustments are of a normal recurring
nature. The results for the three and six months ended
June 30, 2015 are not necessarily indicative of the results to be expected for the year ending December 31, 2015 or for any
other interim period or for any future period. Principles of Consolidation The consolidated financial statements include
the accounts of the Company and its wholly-owned subsidiary. All significant intercompany balances and transactions have been eliminated
in consolidation. Use of Estimates The preparation of the consolidated financial
statements in conformity with accounting principles generally accepted in the US requires management to make estimates and assumptions
that affect amounts reported of assets and liabilities at the date of the financial statements and the reported amount of revenues
and expenses during the reporting periods. Actual results could differ from those estimates and be based on events different from
those assumptions. As of June 30, 2015, the more significant estimates include (1) revenue recognition, including deferred revenues
and valuation allowances of accounts receivable, (2) valuation of intangible assets and (3) stock-based compensation. Revenue Recognition The Company recognizes revenues from product
sales when the following four criteria have been met: (i) the product has been delivered and the Company has no significant remaining
obligations; (ii) persuasive evidence of an arrangement exists; (iii) the price to the buyer is fixed or determinable; and (iv)
collection is reasonably assured. Revenues from product sales are recorded net of provisions for expected returns and cash discounts. The Company ships most of its products FOB shipping
point, although from time to time certain customers, for example governmental customers, will be granted FOB destination terms.
Among the factors the Company takes into account when determining the proper time at which to recognize revenue are (i) when title
to the goods transfers and (ii) when the risk of loss transfers. Shipments to distributors or physicians that do not fully satisfy
the collection criteria are recognized when invoiced amounts are fully paid or fully assured and included in deferred revenues
until that time. For revenue arrangements with multiple deliverables
within a single, contractually binding arrangement (usually sales of products with separately priced extended warranty), each element
of the contract is accounted for as a separate unit of accounting when it provides the customer value on a stand-alone basis and
there is objective evidence of the fair value of the related unit. The Company has two distribution channels for
its phototherapy treatment equipment. The Company either (i) places its lasers in a physicianÂ’s office (at no charge to the
physician), and generally charges the physician a fee for an agreed upon number of treatments or (ii) sells its lasers through
a distributor or directly to a physician. In some cases, the Company and the customer stipulate to a quarterly or other periodic
target of procedures to be performed, and accordingly revenue is recognized ratably over the period. When the Company places a laser in a physicianÂ’s
office, it generally recognizes service revenue based on the number of patient treatments performed, or purchased under a periodic
commitment, by the physician. Amounts collected with respect to treatments to be performed through laser-access codes that are
sold to physicians free of a periodic commitment, but not yet used, are deferred and recognized as a liability until the physician
performs the treatment. Unused treatments remain an obligation of the Company because the treatments can only be performed on Company-owned
equipment. Once the treatments are performed, this obligation has been satisfied. The Company defers substantially all revenue
from sales of treatment codes ordered by its customers within the last two weeks of the period in determining the amount of procedures
performed by its physician-customers. Management believes this approach closely approximates the actual amount of unused treatments
that existed at the end of a period. Deferred revenue includes amounts received with
respect to extended warranty maintenance, repairs and other billable services and amounts not yet recognized as revenues. Revenues
with respect to such activities are deferred and recognized on a straight-line basis over the duration of the warranty period,
the service period or when service is provided, as applicable to each service. Inventories Inventories are stated at the lower of cost
or market. Cost is determined to be purchased cost for raw materials and the production cost (materials, labor and indirect manufacturing
cost, including sub-contracted work components) for work-in-process and finished goods. For the CompanyÂ’s products, cost
is determined on the weighted-average manufacturing process, the related production costs are recorded within inventory. Work-in-process
is immaterial, given the typically short manufacturing cycle, and therefore is disclosed in conjunction with raw materials. The CompanyÂ’s equipment for the treatment
of skin disorders (e.g. the XTRAC for psoriasis or vitiligo) will either (i) be placed in a physicianÂ’s office and remain
the property of the Company (at which date such equipment is transferred to property and equipment) or (ii) be sold to distributors
or physicians directly. The cost to build a laser, whether for sale or for placement, is accumulated in inventory. Reserves for slow moving and obsolete
inventories are provided based on historical experience and product demand. Management evaluates the adequacy of these reserves
periodically based on forecasted sales and market trends. As of June 30, 2015, the Company recorded a write-down of $4,818 towards
the remaining inventory value of the MELAFind systems, raw materials and components. Property, Equipment and Depreciation Property and equipment are recorded at cost,
net of accumulated depreciation. Excimer lasers-in-service are depreciated on a straight-line basis over the estimated useful life
of five years. For other property and equipment, depreciation is calculated on a straight-line basis over the estimated useful
lives of the assets, primarily three to seven years for computer hardware and software, furniture and fixtures, and machinery and
equipment. Leasehold improvements are amortized over the lesser of the useful lives or lease terms. Expenditures for major renewals
and betterments to property and equipment are capitalized, while expenditures for maintenance and repairs are charged as an expense
as incurred. Upon retirement or disposition, the applicable property amounts are deducted from the accounts and any gain or loss
is recorded in the consolidated statements of comprehensive (loss) income. Useful lives are determined based upon an estimate of
either physical or economic obsolescence or both. Management evaluates the realizability of property
and equipment based on estimates of undiscounted future cash flows over the remaining useful life of the asset. If the amount of
such estimated undiscounted future cash flows is less than the net book value of the asset, the asset is written down to fair value.
As of June 30, 2015, the Company recorded a write-down of $920 on the remaining net book value of the MELAFind systems that were
part of property and equipment (see Impairment of Long-Lived Assets and Intangibles Patent Costs and Licensed Technologies Costs incurred to obtain or defend patents and
licensed technologies are capitalized and amortized over the shorter of the remaining estimated useful lives or eight to 12 years.
Core technology and product technology were recorded in connection with the asset purchase on June 22, 2015 and are being amortized
on a straight-line basis over ten years for core technology and five years for product technology. (See Note 5 Patent
and Licensed Technologies Management evaluates the recoverability of intangible
assets based on estimates of undiscounted future cash flows over the remaining useful life of the asset. If the amount of such
estimated undiscounted future cash flows is less than the net book value of the asset, the asset is written down to fair value.
As of June 30, 2015, no such write-down was required. (See Impairment of Long-Lived Assets and Intangibles Other Intangible Assets Other intangible assets were recorded
in connection with the asset purchase on June 22, 2015. The assets that were determined to have definite useful lives are being
amortized on a straight-line basis over ten years. Such assets primarily include customer relationships and trademarks. (See Note
7 Other Intangible Assets) Management evaluates the recoverability of such
other intangible assets based on estimates of undiscounted future cash flows over the remaining useful life of the asset. If the
amount of such estimated undiscounted future cash flows is less than the net book value of the asset, the asset is written down
to fair value. As of June 30, 2015 no such write-down was required. (See Impairment of Long-Lived Assets and Intangibles Accounting for the Impairment of Goodwill The Company evaluates the carrying value of
goodwill annually at the end of the calendar year and also between annual evaluations if events occur or circumstances change that
would more likely than not reduce the fair value of the reporting unit to which goodwill was allocated to below its carrying amount.
Such circumstances could include, but are not limited to: (1) a significant adverse change in legal factors or in business climate,
(2) unanticipated competition, or (3) an adverse action or assessment by a regulator. Goodwill impairment testing involves a two-step
process. Step 1 compares the fair value of the GroupÂ’s reporting units to which goodwill was allocated to their carrying
values. If the fair value of the reporting unit exceeds its carrying value, no further analysis is necessary. The reporting unit
fair value is based upon consideration of various valuation methodologies, including guideline transaction multiples, multiples
of current earnings, and projected future cash flows discounted at rates commensurate with the risk involved. If the carrying amount
of the reporting unit exceeds its fair value, Step 2 must be completed to quantify the amount of impairment. Step 2 calculates
the implied fair value of goodwill by deducting the fair value of all tangible and intangible assets, excluding goodwill, of the
reporting unit, from the fair value of the reporting unit as determined in Step 1. The implied fair value of goodwill determined
in this step is compared to the carrying value of goodwill. If the implied fair value of goodwill is less than the carrying value
of goodwill, an impairment loss, equal to the difference, is recognized. Impairment of Long-Lived Assets and Intangibles Long-lived assets, such as property and equipment,
and definite-lived intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances
indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured
by a comparison of the carrying amount of an asset to the undiscounted cash flows attributable to the asset. If the carrying amount
of an asset exceeds its undiscounted cash flows, an impairment charge is recognized in the amount by which the carrying amount
of the asset exceeds its fair value of the asset. As of June 30, 2015, no such impairment exists. Assets to be disposed of are
separately presented in the balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and
are no longer depreciated. The assets and liabilities of a disposed group classified as discontinued operations are presented
separately in the appropriate asset and liability sections of the balance sheet. Functional Currency The currency of the primary economic environment
in which the operations of the Company are conducted is the US dollar (“$” or “dollars”). Thus, the functional
currency of the Company is the dollar except the operations of its foreign subsidiary, which is conducted in its local currency
the Indian Rupee (INR). Substantially all of the GroupÂ’s revenues are derived in dollars or in other currencies linked to
the dollar. Purchases of most materials and components are carried out in, or linked to the dollar. Balances denominated in, or linked to, foreign
currencies are stated on the basis of the exchange rates prevailing at the balance sheet date. For foreign currency transactions
included in the statement of comprehensive income (loss), the exchange rates applicable to the relevant transaction dates are used.
Transaction gains or losses arising from changes in the exchange rates used in the translation of such balances are carried to
financing income or expenses. Assets and liabilities of the foreign
subsidiary, whose functional currency is its local currency, are translated from its functional currency to U.S. dollars at the
balance sheet date exchange rate. Income and expense items are translated at the average rate of exchange prevailing during the
year. Translation adjustments are reflected in the consolidated balance sheets as a component of accumulated other comprehensive
income (loss). Fair Value Measurements The Company measures and discloses fair value
in accordance with Financial Accounting Standards Board (“FASB”) Accounting Standards Codification 820, Fair
Value Measurements and Disclosures
• Level 1 – unadjusted quoted prices are available in active markets for identical assets or liabilities that the Company has the ability to access as of the measurement date.
• Level 2 – pricing inputs are other than quoted prices in active markets that are directly observable for the asset or liability or indirectly observable through corroboration with observable market data.
• Level 3 – pricing inputs are unobservable for the non-financial asset or liability and only used when there is little, if any, market activity for the non-financial asset or liability at the measurement date. The inputs into the determination of fair value require significant management judgment or estimation. Fair value is determined using comparable market transactions and other valuation methodologies, adjusted as appropriate for liquidity, credit, market and/or other risk factors This hierarchy requires the Company to use observable
market data, when available, and to minimize the use of unobservable inputs when determining fair value. The CompanyÂ’s recurring fair value measurements
at June 30, 2015 and December 31, 2014 are as follows:
Fair Value as Quoted Prices Significant Significant
Liabilities:
Derivative financial instruments (Note 11) $ 2,806 $ — $ — $ 2,806
Fair Value as
Quoted Prices (Level 1)
Significant (Level 2)
Significant (Level 3)
Liabilities:
Derivative financial instruments (Note 11) $ 499 $ — $ — $ 499 The fair value of cash and cash equivalents
and short term bank deposits are based on its demand value, which is equal to its carrying value. The fair value of derivative
warrant liabilities is estimated using option pricing models that are based on the individual characteristics of our warrants,
preferred and common stock, the derivative warrant liability on the valuation date as well as assumptions for volatility, remaining
expected life, risk-free interest rate and, in some cases, credit spread. The derivative warrant liabilities are the only recurring
Level 3 fair value measures. The carrying value of all other short-term monetary assets and liabilities is estimated to be approximate
to their fair value due to the short-term nature of these instruments. The fair value of the senior secured convertible debentures
approximates its carrying value at June 30, 2015 due to the recent issuances of these instruments. The warrants have non-standard terms as they
relate to a fundamental transaction and require a net-cash settlement upon change in control of the Company and therefore are classified
as a derivative. These warrants have been recorded at their fair value using a binomial option pricing model and will be recorded
at their respective fair value at each subsequent balance sheet date. See Note 11, Warrants In addition to items that are measured at fair
value on a recurring basis, there are also assets and liabilities that are measured at fair value on a nonrecurring basis. Assets
and liabilities that are measured at fair value on a nonrecurring basis include certain long-lived assets, including goodwill.
As such, we have determined that each of these fair value measurements reside within Level 3 of the fair value hierarchy. Accrued Warranty Costs The Company offers a standard warranty
on product sales generally for a one to two-year period, however, the Company has offered longer warranty periods, ranging from
three to four years, in order to meet competition or meet customer demands. The Company provides for the estimated cost of the
future warranty claims on the date the product is sold. Total accrued warranty is included in Other Accrued Liabilities
June 30, 2015
(unaudited)
Accrual at beginning of year $ —
Acquired in asset purchase 265
Additions charged to warranty expense 14
Total 279
Less: current portion (158 )
$ 121 Earnings Per Share Basic net loss per common share excludes
dilution for potentially dilutive securities and is computed by dividing net loss attributable to common stockholders by the weighted
average number of common shares outstanding during the period. Diluted net loss per common share gives effect to dilutive options,
warrants and other potential common shares outstanding during the period. Diluted net loss per common share is equal to the basic
net loss per common share since all potentially dilutive securities are anti-dilutive for each of the periods presented. The gain
on the change in fair value of the warrant liability was considered in the diluted earnings per share calculation and was deemed
to be antidilutive for all periods presented. Potential common stock equivalents outstanding as of June 30, 2015 and June 30, 2014
consist of common stock equivalents of common stock purchase warrants, senior secured convertible debentures, convertible preferred
stock, common stock options and unvested restricted stock awards, which are summarized as follows:
June 30,
2015 2014
Common stock equivalents of convertible debentures 47,661,800 * —
Common stock purchase warrants 16,078,920 * 2,084,767
Common stock equivalents of convertible preferred stock 4,007,406 1,464,287
Common stock options 1,293,701 340,028
Restricted stock awards — 2,890
Total 69,041,827 3,891,972 *43,333,334 common stock equivalents of convertible
debentures and 3,000,000 of the common stock purchase warrants will be convertible and exercisable, respectively, upon stockholder
approval. Adoption of New Accounting Standards In April 2014, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standard Update 2014-08, Presentation of Financial Statements (Topic 205)
and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of
an Entity ("ASU 2014-08"). The amendments in ASU 2014-08 change the criteria
for reporting discontinued operations while enhancing disclosures in this area. Under the new guidance, only disposals representing
a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect
on the organizationÂ’s operations and financial results. In addition, the new guidance requires expanded disclosures about
discontinued operations that will provide financial statement users with more information about the assets, liabilities, income,
and expenses of discontinued operations. The provisions of ASU 2014-08 were required
to be applied in a prospective manner to disposals or classifications as held for sale components of an entity that occur with
annual periods beginning on or after December 15, 2014 and interim periods within those years. The adoption of ASU 2014-08 did not have a material
impact on the CompanyÂ’s consolidated results of operations and financial condition. Recently Issued Accounting Standards In July, 2015, The FASB issued Accounting Standards
Update No. 2015-11 , Simplifying the Measurement of Inventory (Topic 330) ASU 2015-11 outlines that inventory within the
scope of its guidance be measured at the lower of cost and net realizable value. Inventory measured using last-in, first-out (LIFO)
are not impacted by the new guidance. Prior to the issuance of ASU 2015-11, inventory was measured at the lower of cost or market
(where market was defined as replacement cost, with a ceiling of net realizable value and floor of net realizable value less a
normal profit margin). For a public entity, the amendments in ASU 2015-11
are effective, in a prospective manner, for annual reporting periods beginning after December 15, 2016, including interim periods
within that reporting period (the first quarter of fiscal year 2017 for the Company). Early adoption is permitted as of the beginning
of an interim or annual reporting period. The Company is in the process of assessing the
impact, if any, of ASU 2015-11 on its consolidated financial statements. In May 2014, The FASB issued Accounting Standards
Update No. 2014-09 , Revenue from Contracts with Customers (Topic 606) ASU 2014-09 outlines a single comprehensive
model to use in accounting for revenue arising from contracts with customers and supersedes most current revenue recognition guidance,
including industry-specific guidance. ASU 2014-09 also requires entities to disclose sufficient information, both quantitative
and qualitative, to enable users of financial statements to understand the nature, amount, timing, and uncertainty of revenue and
cash flows arising from contracts with customers. An entity should apply the amendments in this
ASU using one of the following two methods: 1. Retrospectively to each prior reporting period presented with a possibility to elect
certain practical expedients, or, 2. Retrospectively with the cumulative effect of initially applying ASU 2014-09 recognized at
the date of initial application. If an entity elects the latter transition method, it also should provide certain additional disclosures. For a public entity, the amendments in ASU 2014-09
were to be effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting
period. In July 2015, the FASB voted for a one year deferral of the effective date of ASU 2014-09 and issued an exposure draft.
The new guidance will be effective for annual and interim periods beginning on or after December 15, 2017. Early application is
not permitted. The Company is currently assessing the impact that adopting this new accounting guidance will have on its consolidated
financial statements and footnote disclosures. In August 2014, the FASB issued Accounting Standards
Update No. 2014-15, Presentation of Financial Statements—Going Concern (Subtopic 205-40): Disclosure of Uncertainties
about an EntityÂ’s Ability to Continue as a Going Concern In April 2015, the Financial Accounting
Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) No. 2015-03, “ Simplifying
the Presentation of Debt Issuance Costs (Subtopic 835-30) |
