UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

For the Quarterly Period Ended September 30, 2018

OR

For the Transition Period From              to

Commission file number: 001-38677

Ra Medical Systems, Inc.

(Exact name of Registrant as specified in its charter)

(760) 804-1648

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

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 every Interactive Data File required to be submitted 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 such files).    Yes  ☒    No  ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ☐    No  ☒

As of November 5, 2018, the registrant had 12,689,251 shares of common stock, par value $0.0001, outstanding.

RA MEDICAL SYSTEMS, INC.

QUARTERLY REPORT ON FORM 10-Q

TABLE OF CONTENTS

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PART I — FINANCIAL INFORMATION

Ra Medical Systems, Inc

Condensed Balance Sheets (Unaudited)

(in thousands, except share and per share data)

See notes to condensed financial statements.

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Ra Medical Systems, Inc

Condensed Statements of Operations (Unaudited)

(in thousands, except per share data)

See notes to condensed financial statements.

4

Ra Medical Systems, Inc

Condensed Statement of Stockholders’ Equity (Deficit)  (Unaudited)

(in thousands)

See notes to condensed financial statements.

5

Ra Medical Systems, Inc

Condensed Statements of Cash Flows (Unaudited)

(in thousands)

See notes to condensed financial statements.

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Ra Medical Systems, Inc.

Notes to Condensed Financial Statements (Unaudited)

Note 1—Organization and Nature of Operations

Ra Medical Systems, Inc. (the “Company”) was formed in September 4, 2002, in the state of California and reincorporated in Delaware on July 14, 2018. The Company is a medical device company commercializing advanced excimer lasers for use in the treatment of dermatological and vascular diseases. The Company develops, manufactures and markets medical devices targeting the dermatology and vascular specialties. The Company’s product development centers around proprietary applications of its advance excimer laser technology for use as a tool in the treatment of psoriasis, vitiligo, atopic dermatitis, leukoderma, and peripheral artery disease (“PAD”).

Reincorporation—Upon reincorporation in Delaware, the par value of each share of common stock was established to be $0.0001 and the number of authorized shares of common stock was increased from 10,000,000 to 25,000,000. In connection with the reincorporation, common stock and additional paid-in capital amounts in these financial statements have been adjusted to reflect the par value of common stock. All share information included in these financial statements has been adjusted to reflect this reincorporation.

Initial Public Offering—On October 1, 2018, the Company closed its initial public offering ("IPO") of 4,485,000 shares of common stock at an offering price to the public of $17.00 per share, resulting in gross proceeds of approximately $76.2 million. These amounts include the exercise in full by the underwriters of their option to purchase 585,000 additional shares of common stock at the same price to the public to cover over-allotments. The aggregate net proceeds to the Company from its IPO were $67.3 million after deducting the underwriters discount and offering costs of $5.3 million and $3.6 million, respectively. The Company’s registration statement on Form S-1 relating to its IPO was declared effective by the Securities and Exchange Commission on September 26, 2018. The accompanying condensed financial statements, including share and per share amounts, do not include the effects of the offering as it was completed subsequent to September 30, 2018.  

Note 2—Significant Accounting Policies

Interim condensed financial information— The unaudited interim condensed financial statements included within this report have been prepared on the same basis as the annual financial statements and reflect all adjustments of a normal and recurring nature that are necessary for the fair presentation of the Company’s condensed financial position, results of operations, cash flows and statement of stockholders’ equity (deficit) for the periods presented. The results of operations for the three and nine months ended September 30, 2018 are not necessarily indicative of the results to be expected for the year ending December 31, 2018 or for any other future annual or interim period. The balance sheet as of December 31, 2017 included herein was derived from the audited financial statements as of that date. These unaudited condensed financial statements should be read in conjunction with the Company’s audited financial statements included in the Company’s final prospectus filed with the SEC on September 27, 2018 relating to the Company’s Registration Statement on Form S-1 (File No. 333-226191).

Use of estimates—The preparation of the financial statements requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and reported disclosures of contingent assets and liabilities at the dates of the financial statements and the reported amounts of revenue and expenses during the reporting periods. Actual results could differ from those estimates. The Company’s financial statements are based upon a number of estimates, including but not limited to, allowance for doubtful accounts, inventory reserves, reserves for warranty costs, fair value of stock option awards granted and revenue recognition for multiple element arrangements.

Deferred Initial Public Offering Costs—The Company capitalizes certain legal, accounting and other third party fees that are directly associated with in-process equity financings until such financings are consummated. Deferred IPO costs of $3.6 million are capitalized and included within Other non-current assets on the condensed balance sheet as of September 30, 2018. There were no deferred IPO costs as of December 31, 2017. The deferred IPO costs will be offset against the proceeds from the IPO in the fourth quarter of 2018 as a component of stockholders’ equity.

Recent accounting pronouncements—On April 5, 2012, President Obama signed the Jump-Start Our Business Startups Act (the “JOBS Act”) into law. The JOBS Act contains provisions that, among other things, reduce certain reporting requirements for an emerging growth company. As an emerging growth company, the Company may elect to adopt new or revised accounting standards when they become effective for non-public companies, which typically is later than public companies must adopt the standards. The Company has elected to take advantage of the extended transition period afforded by the JOBS Act and, as a result, will comply with new or revised accounting standards on the relevant dates on which adoption of such standards is required for non-public companies, which are the dates included below.

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In May 2014, FASB issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606), and issued subsequent amendments to the initial guidance in August 2015, March 2016, April 2016 and May 2016 within ASU 2015-14, ASU 2016-08, ASU 2016-10 and ASU 2016-12, respectively. ASU 2014-09 supersedes nearly all existing revenue recognition guidance under generally accepted accounting principles in the United States (“US GAAP”). The core principle of ASU 2014-09 is to recognize revenue when promised goods or services are transferred to customers in an amount that reflects the consideration that the Company expects to receive for those goods or services. ASU 2014-09 defines a five-step process to achieve this core principle, and in doing so, it is possible more judgment and estimates may be required within the revenue recognition process than are required under existing US GAAP, including identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation, among others. The new standard also requires an entity to recognize as an asset the incremental costs of obtaining a contract with a customer if the entity expects to recover those costs. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2018, and interim reporting periods within annual reporting periods beginning after December 15, 2019, with (i) retrospective application of ASU 2014-09 to each prior reporting period presented with the option to elect certain practical expedients as defined within ASU 2014-09 or (ii) retrospective application of ASU 2014-09 with the cumulative effect of initially applying ASU 2014-09 recognized at the date of initial application and providing certain additional disclosures as defined per ASU 2014-09 (the modified retrospective method).

While the Company has not completed its evaluation, the Company currently plans to adopt this accounting standard in the first quarter of fiscal year 2019 using the modified retrospective method. Based on the analysis performed through the third quarter of 2018, the Company does not believe adoption of this guidance will have a material impact on the timing and measurement of revenue under its contracts with customers, but it will require additional disclosures.

In February 2016, FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”). This update requires lessees to recognize on the balance sheet a lease liability and a lease asset for all leases with a term greater than 12 months, including operating leases. The update also expands the required quantitative and qualitative disclosures surrounding leases. Under the new standard, the Company will have to recognize a liability representing its lease payments and a right-of-use asset representing its right to use the underlying asset for the lease term on the balance sheet. ASU 2016-02 is effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020, with early adoption permitted.

Lessor accounting under ASU 2016-02 is similar to the current model but updated to align with certain changes to the lessee model. Lessors will continue to classify leases as operating, direct financing or sales-type leases. In addition, the new standard requires that lease and nonlease components of a contract be bifurcated, with nonlease components subject to the new revenue recognition standard effective upon adoption of the new leasing standard. In January 2018, the FASB issued a proposed amendment that, if adopted by the FASB, would allow lessors to elect to account for the lease and nonlease components as a single combined lease component if (i) the timing and pattern of the revenue recognition is the same, and (ii) the combined lease component would continue to be classified as an operating lease. The Company is evaluating the effect that this guidance will have on the financial statements and related disclosures. The Company plans to adopt the standard using the transition method provided by ASC Update No. 2018-11, Leases (Topic 842): Targeted Improvements. Under this method, the Company plans to initially apply the new leasing rules on January 1, 2019, and recognize the cumulative effect of initially applying the standard as an adjustment to our opening balance of retained earnings, rather than at the earliest comparative period presented in the financial statements.

In May 2017, the FASB issued ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. The amendments in this update provide guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. Under the ASU, an entity will account for the effects of a modification unless (i) the fair value of the modified award is the same as the fair value of the original award immediately before the original award is modified, (ii) the vesting conditions of the modified award are the same vesting conditions as the original award immediately before the original award is modified and (iii) the classification of the modified award as an equity instrument or a liability instrument is the same as the classification of the original award immediately before the original award is modified. The amendments in this ASU are effective prospectively for fiscal years, and interim periods within those annual periods, beginning after December 15, 2017. The Company adopted ASU 2017-09 on January 1, 2018 and the adoption did not have a material impact on the Company’s financial statements or related financial statement disclosure.

In June 2018, the FASB issued ASU 2018-07, Improvements to Nonemployee Share-Based Payment Accounting. ASU 2018-07 expands the scope of Topic 718, Compensation—Stock Compensation, to include share-based payments issued to nonemployees for goods or services. Consequently, the accounting for share-based payments to nonemployees and employees will be substantially aligned. ASU 2018-07 supersedes Subtopic 505-50, Equity—Equity-Based Payments to Non-Employees. The amendments are effective for fiscal years beginning after December 15, 2019, and interim periods within fiscal years beginning after December 15, 2020. Early adoption is permitted, but no earlier than a company’s adoption date of Topic 606, Revenue from Contracts with Customers. The Company is evaluating the effect that this guidance will have on the financial statements and related disclosures.

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Note 3—Inventories, net

Inventories consisted of the following (in thousands):

Note 4—Property and Equipment, net

Property and equipment consisted of the following (in thousands):

Depreciation expense was $0.2 million and $0.1 million for the three months ended September 30, 2018 and 2017, respectively, and was $0.4 million and $0.1 million for the nine months ended September 30, 2018 and 2017, respectively.

Note 5—Other non-current assets

Other non-current assets consisted of the following (in thousands):

Note 6—Accrued Expenses

Accrued expenses consisted of the following (in thousands):

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Note 7—Accrued Warranty

Activity in the product warranty accrual is included in accrued expenses above and consists of the following (in thousands):

Warranty expense was $0.03 million for both the three months ended September 30, 2018 and 2017, respectively, and was $0.1 million for each of the nine months ended September 30, 2018 and 2017, respectively, and is included in service and other cost of revenue in the accompanying condensed statements of operations.

Note 8—Stockholders’ Equity

Common stock—The Company has one class of stock: common shares. The Company issued 316,080 shares of common stock in exchange for $7.9 million that related to the private placements which took place during the nine months ended September 30, 2018. The Company’s Registration Statement on Form S-1 for its initial public offering was effective September 26, 2018 and the transaction closed on October 1, 2018, at which time the Company issued 4,485,000 shares of common stock in exchange for net proceeds of approximately $67.3 million after deducting underwriting discounts and commissions and  offering expenses payable by the Company.

Note 9—Loss per Share

The Company calculates basic loss per share by dividing net loss by the weighted average number of common shares outstanding during the reporting period. Diluted loss per share would reflect the effects of potentially dilutive securities, if any. For each of the three and nine months ended September 30, 2018 and 2017, basic and diluted loss per share were the same.

Note 10—Stock-Based Compensation

In 2003, the Company adopted a stock option plan (the “2003 Plan”), which authorized the board of directors to grant stock option awards to eligible employees, directors, consultants and service providers (together the “Optionees”) of the Company. In April 2012, such plan expired. In 2014, the Company established the 2014 Stock Option Plan (the “2014 Plan”) whereby 1,000,000 shares of the Company’s common stock were reserved for issuance to eligible Optionees. The 2014 Plan provided for the grant of incentive stock options, non-statutory stock options, stock bonuses and rights to acquire restricted stock. Option awards under the 2014 Plan expired up to a maximum of 10 years from the date of the grant.

The Company concluded that option awards communicated to Optionees (the “Communicated Option Awards”) under the 2003 Plan and 2014 Plan were not validly authorized and therefore were not valid outstanding option awards. Although the Communicated Option Awards were not outstanding options, the Company believes the awards represented a contractual obligation to the Optionees and therefore the Company classified the option awards as liabilities in the financial statements which were remeasured at fair value each reporting period.

Obligations under the 2003 Plan and 2014 Plan included time and performance-based awards. For time-based awards, vesting generally occurred over the service period of up to four years. Performance based awards vested at the time that the underlying performance conditions were met.

The liabilities for stock-based compensation awards were classified as a component of noncurrent liabilities on the balance sheet as the Company did not expect that such amounts would be settled through the use of current assets or through the creation of current liabilities.

On May 17, 2018, the Company’s board of directors terminated the 2014 Stock Option Plan and on June 4, 2018, it was replaced with the 2018 Stock Compensation Plan (the “Compensation Plan”) whereby 3,300,000 shares of the Company’s common stock were reserved for issuance. On June 4, 2018, the Company’s board of directors authorized 1,901,900 replacement equity awards of stock options and, on June 8, 2018, 1,340,832 restricted stock units (collectively, the “Replacement Awards”) to the Optionees. On various dates in June 2018, but after the board of directors’ authorization, the Replacement Awards were communicated to the Optionees in exchange for the cancellation of, and waiver to any claims related to, the Communicated Option Awards granted under the 2003 Plan and 2014 Plan which were determined to be not validly authorized. The issuance of the Replacement Awards and cancellation of the Communicated Option Awards was treated as a modification. The modification date is the date of the grant of the Replacement Awards, such date being June 4, 2018, for

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options and June 8, 2018, for restricted stock unit awards. The Company will recognize the remaining unrecognized compensation cost, as well as any incremental compensation cost of the Replacement Awards of $17.2 million, over the remaining service period of the Replacement Awards, as described below. As the Replacement Awards have been determined to be equity-classified awards, the Company will no longer record such awards as liabilities.

In September 2018, the Company’s board of directors adopted, and the Company’s stockholders approved, the Company’s 2018 Equity Incentive Plan (the “2018 Plan”).  The 2018 Plan became effective on September 25, 2018.  A total of 1,632,134 shares of common stock are reserved for issuance pursuant to the Company’s 2018 Plan. In addition, the shares reserved for issuance under the 2018 Plan include (1) those shares reserved but unissued under the Compensation Plan as of the date of stockholder approval of the 2018 Plan and (2) shares of common stock subject to or issued pursuant to awards granted under the Compensation Plan that, after the date of stockholder approval of the 2018 Plan, expire or otherwise terminate without having been exercised in full or are forfeited to or repurchased by us (provided that the maximum number of shares that may be added to the 2018 Plan pursuant to (1) and (2) is 3,300,000 shares).   The 2018 Plan provides for the grant of incentive stock options, within the meaning of Section 422 of the Internal Revenue Code  to the Company’s employees and any of the Company’s  parent and subsidiary corporations’ employees, and for the grant of nonstatutory stock options, restricted stock, restricted stock units, stock appreciation rights, performance units and performance shares to the Company’s employees, directors and consultants and the Company’s parent and subsidiary corporations’ employees and consultants. The number of shares available for issuance under the Company’s 2018 Plan also includes an annual increase on the first day of each fiscal year beginning with our 2019 fiscal year, equal to the least of 1) 1,632,134 shares; 2) five percent (5%) of the outstanding shares of our common stock as of the last day of the immediately preceding fiscal year; or 3) such other amount as our board of directors may determine.

Stock options granted under the Compensation Plan, including those granted as a component of the Replacement Awards, generally vest 33% at the first anniversary of the grant date with the balance vesting monthly over the remaining two years. The restricted stock units granted under the Compensation Plan, including those granted as a component of the Replacement Awards, include a service condition and a performance condition. The service condition generally begins on the grant date and continues through January 2020 and the restricted stock units vest at various times commencing the day following the expiration of the lock-up until January 2020. The performance condition related to the Company completing its IPO and the vesting of the restricted stock units were contingent upon the achievement of such IPO.

A summary of the activity and related information of the Communicated Option Awards classified as liabilities and communicated during the nine months ended September 30, 2018, is presented below:

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A summary of the activity and related information of the stock options issued during the nine months ended September 30, 2018 is presented below:

A summary of the activity and related information of the restricted stock units issued during the nine months ended September 30, 2018 is presented below:

Stock-based compensation expense recorded in operating expenses was as follows (in thousands):

Stock-based compensation of $0.1 million was capitalized to inventory during both the three months ended September 30, 2018 and 2017, respectively and stock-based compensation of $0.4 million and $0.7 million were capitalized to inventory during the nine months ended September 30, 2018 and 2017, respectively.

Unrecognized compensation expense for stock options issued as of September 30, 2018 was $15.6 million and is expected to be recognized over a weighted-average period of 2.7 years. Unrecognized compensation expense for the restricted stock units as of September 30, 2018 was $38.7 million and is subject to the performance condition explained above.

The Communicated Option Awards are presented as a stock-based compensation liability which was revalued at each reporting period with the change in fair value recorded to compensation expense. As of December 31, 2017 and September 30, 2018, the stock-based compensation liability was $15.4 million and $0, respectively. As of the date of the modification of the Communicated Option Awards, the stock-based compensation liability was $18.2 million.

The fair value of the Communicated Option Awards classified as liabilities was estimated using the Black Scholes option pricing model and the weighted-average assumptions used in the model are noted in the following table:

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The weighted-average fair value for Communicated Option Awards granted during the three months ended September 30, 2017 was 18.57 and during the nine months ended September 30, 2018 and 2017 was $14.00 and $8.15, respectively. No Communicated Option Awards were granted during the three months ended September 30, 2018. The Company’s shares were not traded on any public market during the term of the Communicated Option Awards. The common stock value as of the date of grant was based on the share price of recent equity issuances, if available. If there were no such recent transactions, the Company’s share valuation was estimated. As of December 31, 2017, the date at which the stock-based compensation liability was remeasured at fair value, the common stock price was based on the recent equity issuances with third party investors, who were not previous shareholders of the Company. As of the date of the modification of the Communicated Option Awards, which resulted in the settlement of the stock-based compensation liability, the common stock price was estimated utilizing a hybrid method, a combination of the Probability Weighted Expected Return Method (“PWERM”) and Option Pricing Model (“OPM”). The estimate incorporated a near-term IPO scenario using PWERM weighted at 80%. Other near-term exit events, a long-term stay private case, and dissolution were all considered as non-IPO scenarios using OPM, and were weighted at 20%. The estimate also reflected a 10% and 15% discount for lack of marketability under PWERM and OPM, respectively. The risk free interest rate approximates the implied yield available on United States Treasury securities with an equivalent remaining term. Expected volatility is based on the historical volatilities of certain “guideline” companies. Expected dividend yield is based on dividends historically paid by the Company. The expected life is based on the “simplified” method using the average of the term and vesting period.

The fair value of the stock options issued was estimated using the Black Scholes option pricing model and the weighted-average assumptions used in the model are noted in the following table:

The weighted average fair value for the stock options granted during the nine months ended September 30, 2018 was $12.91. No stock options were granted during the three months ended September 30, 2018. The Company’s shares were not traded in any public market at the stock option grant dates during the first nine months of 2018. For purposes of determining the fair value of the Company’s common stock for the grants made in June 2018, the Company utilized a hybrid method, a combination of the PWERM and OPM as described above. The risk free interest rate approximates the implied yield available on United States Treasury securities with an equivalent remaining term. Expected volatility is based on the historical volatilities of certain “guideline” companies. Expected dividend yield is based on dividends historically paid by the Company. The expected life is based on the “simplified” method using the average of the term and vesting period.

The Company’s 2018 Employee Stock Purchase Plan (ESPP) became effective in September 2018. A total of 296,752 shares of common stock are available for sale under our ESPP as of September 30, 2018. The number of shares of common stock that will be available for sale under the ESPP also includes an annual increase on the first day of each fiscal year beginning with our 2019 fiscal year, equal to the least of (1) 296,752 shares; (2) one and one quarter percent (1.25%) of the outstanding shares of our common stock as of the last day of the immediately preceding fiscal year; or (3) such other amount as the administrator may determine.

Note 11—Commitments and Contingencies

Capital stock transactions—The Company has determined that there have been defects with respect to certain capital stock transactions, including stock issuances and a reverse stock split, which were not effected in accordance with the requirements of applicable law. The Company could be subject to claims based on the defects. The Company believes any loss as a result of such defects is remote.

Legal—In the normal course of business, the Company is at times subject to pending and threatened legal actions. In management’s opinion, any potential loss resulting from the resolution of these matters will not have a material effect on the results of operations, financial position or cash flows of the Company.

On August 30, 2018, Strata Skin Sciences, Inc. and Uri Geiger, a member of the board of directors of Strata Skin Sciences, Inc. (collectively “Strata”) filed an action against the Company in Pennsylvania State Court, Montgomery County (Civil Action No. 18-21421), requesting declaratory relief that: (1) Strata is not liable for tortious interference, defamation, libel, or unfair competition based on an e-mail by Mr. Geiger to an investment bank (the “Geiger Email”); (2) Strata made no actionable

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statements about the Company to such investment bank; (3) the Company cannot enforce the 2011 settlement and release agreement between the Company and PhotoMedex, Inc. (“Settlement Agreement”) against Strata; and (4) that any dispute regarding the Geiger Email does not relate to the Settlement Agreement. The action filed by Strata does not request any monetary damages. The Company believes that the action by Strata was filed as a response to a letter that the Company sent to Strata on August 22, 2018 demanding that Strata and Mr. Geiger cease and desist from making statements about alleged patent infringement and affirmatively retract the statements made in the Geiger Email.  The Company was served with the action on August 31, 2018, and responded with preliminary objections to the action on September 19, 2018. The Company believes that Strata’s action lacks merit, and plans to vigorously oppose the action on procedural and substantive grounds within the prescribed time limits.

Lease commitments—The Company has various noncancelable operating leases related to office spaces and manufacturing facilities in Carlsbad, California. In 2017, the Company entered into a new operating lease for office space and manufacturing facilities and abandoned its old leases.

Some of these agreements have escalating rent payment provisions. Rent expense under such agreements is recognized on a straight-line basis. Total rent expense for the three months ended September 30, 2018 and 2017 was $0.1 million and $0.1 million, respectively and $0.3 million and $0.2 million for the nine months ended September 30, 2018 and 2017, respectively.

Future minimum rental payments due are as follows (in thousands):

The Company recorded an expense and a corresponding liability of $0.2 million as of December 31, 2017 as a result of the lease abandonment, which represents the fair value of the lease termination costs upon initial measurement. The liability includes the estimated costs, net of estimated subleasing proceeds, the Company expects to incur during the lease term using the credit-adjusted risk-free interest rate. The initial expense was recorded in selling, general and administrative expenses in the statement of operations in the fourth quarter of 2017. The initial liability measured at fair value less amortization is included in accrued expenses and other liabilities on the accompanying balance sheet as of December 31, 2017 and September 30, 2018. In periods subsequent to initial measurement, changes to the liability will be measured using the credit-adjusted risk-free rate that was used to measure the liability initially.

Note 12—Segment Information

The Company has organized its business into two operating segments based on the product specialties: the dermatology segment and the vascular segment.

In deciding how to allocate resources and assess performance, the Company’s chief operating decision maker regularly evaluates the sales and gross profit of these segments. Amounts included within selling, general and administrative expense and research and development expense are general to the Company and not specific to a particular segment; therefore, these amounts are not evaluated by the Company’s chief operating decision maker on a segmented basis.

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The following tables summarize segment performance for the three and nine months ended September 30, 2018 and 2017 (in thousands):

Generally, all assets are common assets, except for demonstration lasers and lasers placed with customers, which are a subset of property and equipment. Demonstration lasers and lasers placed with customers aggregated in the vascular segment was $1.2 million and $0.2 million as of September 30, 2018 and December 31, 2017, respectively. Demonstration lasers and lasers placed with customers aggregated in the dermatology segment was $0.9 million and $0.3 million as of September 30, 2018 and December 31, 2017, respectively.

No sales to an individual customer or country other than the United States accounted for more than 10% of net revenue for the three or nine months ended September 30, 2018 or 2017. Net revenue, classified by the major geographic areas in which our customers are located, was as follows:

Note 13—Subsequent Events

Initial Public Offering

See Note 1.

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Special Notes Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q contains forward-looking statements that are based on our management’s beliefs and assumptions and on information currently available. This section should be read in conjunction with our unaudited condensed financial statements and related notes included in Part I, Item 1 of this report. The statements contained in this Quarterly Report on Form 10-Q that are not historical facts are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended.

Forward-looking statements can be identified by words such as “believe,” “anticipate,” “may,” “might,” “can,” “could,” “continue,” “depends,” “expect,” “expand,” “forecast,” “intend,” “predict,” “plan,” “rely,” “should,” “will,” “may,” “seek,” or the negative of these terms or and other similar expressions, although not all forward-looking statements contain these words. You should read these statements carefully because they discuss future expectations, contain projections of future results of operations or financial condition, or state other “forward-looking” information. These statements relate to our future plans, objectives, expectations, intentions and financial performance and the assumptions that underlie these statements.

These forward-looking statements are subject to a number of risks, uncertainties, and assumptions, including, but not limited to, those described in “Risk Factors”. These forward-looking statements reflect our beliefs and views with respect to future events and are based on estimates and assumptions as of the date of this Quarterly Report on Form 10-Q and are subject to risks and uncertainties. We discuss many of these risks in greater detail in the section entitled “Risk Factors” included in Part II, Item 1A and elsewhere in this report. Given these uncertainties, you should not place undue reliance on these forward-looking statements. We qualify all of the forward-looking statements in this Quarterly Report on Form 10-Q by these cautionary statements. Except as required by law, we assume no obligation to update these forward-looking statements publicly, or to update the reasons actual results could differ materially from those anticipated in any forward-looking statements, whether as a result of new information, future events or otherwise.

This Quarterly Report on Form 10-Q also contains estimates, projections and other information concerning our industry, our business, and the markets for certain diseases, including data regarding the estimated size of those markets. Information that is based on estimates, forecasts, projections, market research or similar methodologies is inherently subject to uncertainties and actual events or circumstances may differ materially from events and circumstances reflected in this information. Unless otherwise expressly stated, we obtained this industry, business, market, and other data from reports, research surveys, studies, and similar data prepared by market research firms and other third parties, industry, medical and general publications, government data, and similar sources.

Overview

We are a commercial-stage medical device company leveraging our advanced excimer laser-based platform for use in the treatment of vascular and dermatological diseases. We believe our products enhance patients’ quality of life by restoring blood-flow in arteries and clearing chronic skin conditions. In June 2018, we completed our 12 month commercial launch period, which included training, production, and staffing for the marketing of the DABRA laser system and disposable catheter, together referred to as DABRA, in the United States. Following the temporary placement period for DABRA and once our customers decide to continue using DABRA in their facilities, we typically enter into DABRA laser commercial usage agreements or DABRA laser placement acknowledgements with each customer, which we refer to collectively as Usage Agreements. As of September 30, 2018, we had 34 signed usage agreements for use of our DABRA laser systems in the U.S. DABRA is cleared by the U.S. Food and Drug Administration, or FDA, as a device for crossing chronic total occlusions, or CTOs, in patients with symptomatic infrainguinal lower extremity vascular disease and with an intended use for ablating a channel in occlusive peripheral vascular disease. DABRA is used as a tool in the treatment of peripheral artery disease, or PAD, a form of peripheral vascular disease, which commonly occurs in the legs. These procedures are typically referred to in the medical community as atherectomy procedures, which the medical community commonly defines as any removal by surgery or specialized catheterization of an atheroma, or blockage, in an artery. Even though the medical community refers to it as atherectomy, DABRA is not cleared for atherectomy. Nevertheless, third-party health payers can reimburse a procedure performed by a device which is not cleared or approved for a specific indication or procedure, if the physician determines the device and procedure are medically appropriate for a particular patient. Payers and the medical community can take a broader view than FDA in recognizing the scope of appropriate device use. We currently intend to pursue expanded indications for use for DABRA to include an atherectomy indication for use, which FDA currently defines to include a prespecified improvement in luminal patency, or a prespecified increase in the openness of the artery at a pre-defined time point, and an indication for use for the treatment of in-stent restenosis. To satisfy FDA’s data requirements to support an atherectomy indication, we believe that we will need to perform a new clinical study or collect real-world data that demonstrates an acceptable level of openness of the artery at a pre-defined time point, such as six months following a DABRA procedure, using a consistent assessment tool, e.g., an ultrasound. We believe this will allow FDA to evaluate the clinical success of a DABRA atherectomy procedure.

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At this time, our strategy to collect the data necessary to expand our indications is not yet certain based on numerous factors, including potential feedback from FDA. If we need to conduct a new clinical study, we may need to obtain FDA approval for an Investigational Device Exemption, or IDE, prior to initiating the study. However, we believe that while these activities will take time to complete, the incremental cost of obtaining an atherectomy indication will not be material. In addition, we intend to pursue additional uses for DABRA, including seeking regulatory clearance for the use of DABRA as a tool for the treatment of vascular blockages associated with coronary artery disease, or CAD, in-stent restenosis, and other venous and arterial occlusions, or blockages in the veins or arteries. However, there can be no assurance that DABRA will receive the necessary clearances for these additional indications. The DABRA laser system is based on the same core technology and utilizes a similar excimer laser as Pharos, a medical device that we have marketed as a tool for the treatment of proliferative skin conditions since October 2004. Pharos is designed for use in the treatment of inflammatory skin conditions and is FDA cleared as a tool used in the treatment of psoriasis, vitiligo, atopic dermatitis, and leukoderma. Because DABRA and Pharos are both based on our core excimer laser technology platform and deploy similar mechanisms of action, we benefit from economies of scale in product development, manufacturing, quality assurance and distribution.

DABRA is our minimally-invasive excimer laser and disposable catheter system that is used by physicians as a tool in the endovascular treatment of vascular blockages resulting from lower extremity vascular disease, a form of PAD, both above- and below-the-knee, by breaking down plaque to its fundamental chemistry, such as proteins, lipids and other chemical compounds, eliminating blockages by essentially dissolving them without generating potentially harmful particulates. The accumulation of plaque in arteries, which is a result of lower extremity vascular disease, most commonly occurs in the pelvis and legs. Plaque accumulation, known as atherosclerosis, causes the narrowing of arteries, thereby reducing the flow of oxygenated blood to tissue and organs. If vascular blockages are left untreated, they can increase the risk of heart attack, stroke, amputation or death. Major risk factors for PAD include age, smoking, diabetes and obesity. Despite its prevalence, PAD is underdiagnosed and undertreated relative to many other serious vascular conditions, including CAD, in part because up to half of the PAD population is asymptomatic, or shows no symptoms, and many dismiss symptoms as normal signs of aging. Recent analysis suggests that approximately 17.6 million people in the U.S. suffer from PAD. However, only 20-30% of PAD patients are actively being treated. We anticipate revenue from this recently commercialized business segment to grow over the near term. Our sales strategy includes either selling the DABRA laser with a transfer in title or placing it in high-volume practices for a nominal periodic fee while we retain title. We sell extended warranties for our lasers that have been purchased. Each vascular procedure requires the one-time use of our proprietary catheters which we expect to be the primary source of revenue for the vascular segment. Therefore, under both the sale and periodic fee options, we anticipate recurring revenue in catheter sales for each laser in operation. We currently use our internal sales force to target the U.S. market and we utilize distributors outside the U.S. The current retail price of the DABRA laser is approximately $70,000 and of a DABRA catheter is $1,200. We believe our manufacturing facility is capable of producing 400 lasers per year and 140,000 catheters per year.  

Pharos is our excimer laser device that emits highly concentrated ultraviolet light and is used as a tool in the treatment of dermatological skin disorders. Physicians use Pharos by applying 308 nanometer ultraviolet light to the skin. The FDA has granted 510(k) clearance to market Pharos in the U.S. for psoriasis, vitiligo, atopic dermatitis, and leukoderma. Pharos was granted CE mark clearance in September of 2016 for use in the treatment of psoriasis, vitiligo, atopic dermatitis and leukoderma by the application of UVB ultraviolet light. We have also received clearance to market Pharos from the China Food and Drug Administration, or CFDA, and South Korea Ministry of Drug Safety, or KFDA in the applicable jurisdictions. Pharos was commercialized in 2004 and we have shipped over 1,000 systems to customers globally through September 30, 2018. Pharos is in use in nearly every U.S. state and in over 20 markets including several non-U.S. countries. While we have entered into periodic fee arrangements, our primary strategy is to sell Pharos. We recognize additional recurring revenue from the sale of extended warranties for Pharos. We do not anticipate significant organic revenue growth in the near term from this mature product line. The current retail price of Pharos is approximately $70,000.

We incurred net losses of $15.9 million, and $17.8 million for the nine months ended September 30, 2018 and the year ended December 31, 2017, respectively, and had an accumulated deficit of $45.3 million as of September 30, 2018. As of September 30, 2018, we had available cash and cash equivalents of approximately $4.9 million and had current liabilities of approximately $6.8 million and long-term liabilities of approximately $0.9 million. As of September 30, 2018, we had no preferred stock outstanding and no indebtedness through commercial loans, other than the equipment financings of $30,000. Since inception, we have financed our operations primarily through sales of our products and services, the net proceeds from our initial public offering, and, to a lesser extent, private placements of our common stock and debt financing arrangements. We expect to continue to incur net losses for the near term as we commercialize our products in the U.S., including building our sales and marketing organization and expanding our manufacturing facilities, continuing research and development efforts, and seeking regulatory clearance for new products and product enhancements, including new indications, both in the U.S. and in select non-U.S. markets. We may need additional funding to pay expenses relating to our operating activities, including selling, general and administrative expenses and research and development expenses. If needed, adequate funding may not be available to us on commercially acceptable terms, or at all. Our failure to obtain sufficient funds on acceptable terms when needed could have a material adverse effect on our business, financial condition, and results of operations.

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Initial Public Offering

On October 1, 2018, we closed on our initial public offering ("IPO") of 4,485,000 shares of common stock at an offering price of $17.00 per share, which included the full exercise of the underwriters’ option to purchase 585,000 additional shares of our common stock. We raised a total of $76.2 million in gross proceeds from the IPO, or approximately $67.3 million in net proceeds after deducting underwriting discount and commissions of $5.3 million and offering costs of $3.6 million. Our registration statement on Form S-1 relating to our IPO was declared effective by the Securities and Exchange Commission on September 26, 2018. The accompanying condensed financial statements, including share and per share amounts, do not include the effects of the offering as it was completed subsequent to September 30, 2018.

Components of our Results of Operations

Net revenue

Product sales consist of the sale of DABRA and Pharos lasers, the sale of catheters for use with the DABRA laser and the sale of consumables and replacement parts.

Service and other revenue consists primarily of sales of extended warranties which is recognized over the contract period and billable services, including repair activity, which is recognized when the service is provided. It also includes income from the rental of our lasers.

We currently use our internal sales force to target the U.S. market, and we utilize distributors outside the U.S. in markets where we have received regulatory approval. We will continue to seek regulatory approvals for our products in additional strategic markets.

Cost of revenue and gross margin

Cost of revenue for product sales consists primarily of costs of components for use in our products, the materials and labor that are used to produce our products, and the manufacturing overhead that directly support production.

Cost of revenue for service and other includes the cost of maintaining and servicing the warranties on our products.

We expect cost of revenue to increase to the extent our total revenue grows.

We calculate gross margin as gross profit divided by total net revenue. Our gross margin has been and will continue to be affected by a variety of factors, primarily production volumes, the cost of direct materials, discounting practices, manufacturing costs, product yields, headcount and cost-reduction strategies. We expect our gross margin to increase over the long term as our production volume increases and certain costs remain fixed. We intend to use our design, engineering and manufacturing capabilities to further advance and improve the efficiency of our manufacturing processes, which we believe will reduce costs and increase our gross margin. While we expect gross margin to increase over the long term, it will likely fluctuate from quarter to quarter as we continue to introduce new products and adopt new manufacturing processes and technologies.

Research and development expenses

Research and development, or R&D, expenses consist of applicable personnel, consulting, materials and clinical trial expenses. R&D expenses include: