UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
FORM 10-Q
☒ | QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 | |
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For the quarterly period ended September 30, 2019
2020
OR
☐ | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
For the transition period from ___ to ___
Commission File Number 001-36305
SEMLER SCIENTIFIC, INC.
(Exact name of registrant as specified in its charter)
Delaware | 26-1367393 | |
(State or other jurisdiction of | (I.R.S. Employer | |
incorporation or organization) | Identification |
911 Bern Court, Suite 110San Jose, CA 95112
2340-2348 Walsh Avenue, Suite 2344 Santa Clara, CA95051 |
(Address of principal executive offices) (Zip Code) (877) 774-4211 |
(Registrant’s telephone number, including area code) |
(Address of principal executive offices) (Zip Code)
(877) 774-4211
(Registrant's telephone number, including area code)
Securities registered pursuant to Section 12(b) of the Act: None.
Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||
N/A | N/A | N/A |
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yesx☒ No¨
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Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yesx☒ No¨
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Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.:Act:
Large Accelerated Filer | ☐ | Accelerated Filer | ☒ | ||||
Non-Accelerated Filer | ☐ | Smaller Reporting Company | ☒ | ||||
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Emerging growth company | ☐ | | |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨
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Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes¨☐ Nox☒
As of November 1, 2019,2, 2020, there were 6,527,9166,658,114 shares of the issuer’s common stock, $0.001 par value per share, outstanding.
TABLE OF CONTENTS
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Management’s Discussion and Analysis of Financial Condition and Results of Operations | 13 | ||
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CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements. Such forward-looking statements include those that express plans, anticipation, intent, contingency, goals, targets or future development and/or otherwise are not statements of historical fact. These forward-looking statements are based on our current expectations and projections about future events and they are subject to risks and uncertainties known and unknown that could cause actual results and developments to differ materially from those expressed or implied in such statements.
These include risks relating to our strategy, our products and services, our preliminary estimates of variable-fee license revenues, as well as risks relating to the healthcare industry, a heavily regulated environment and the markets we and our customers operate in, including the ongoing COVID-19 pandemic.
In some cases, you can identify forward-looking statements by terminology, such as “expects,” “anticipates,” “intends,” “estimates,” “plans,” “believes,” “seeks,” “may,” “should,” “continue,” “could” or the negative of such terms or other similar expressions. Accordingly, these statements involve estimates, assumptions and uncertainties that could cause actual results to differ materially from those expressed in them. Any forward-looking statements are qualified in their entirety by reference to the factors discussed throughout this report.
You should read this quarterly report and the documents that we reference herein and therein and have filed as exhibits to this report, completely and with the understanding that our actual future results may be materially different from what we expect. You should assume that the information appearing in this quarterly report is accurate as of the date of this report only. Because the risk factors referred to above could cause actual results or outcomes to differ materially from those expressed in any forward-looking statements made by us or on our behalf, you should not place undue reliance on any forward-looking statements. TheseThe risks and uncertainties, along with others, are described above under the heading “Risk Factors” in our annual report on Form 10-K filed with the Securities and Exchange Commission, or SEC, on March 7, 2019.9, 2020, along with risks related to the ongoing COVID-19 pandemic and other risks could impact these forward-looking statements. Further, any forward-looking statement speaks only as of the date on which it is made, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events. New factors emerge from time to time, and it is not possible for us to predict which factors will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. We qualify all of the information presented in this quarterly report, and particularly our forward-looking statements, by these cautionary statements.
ii
PART I—FINANCIAL INFORMATION Semler Scientific, Inc. Condensed Statements of Income Unaudited (In thousands of U.S. Dollars, except share and per share data) For the three months ended September 30 For the nine months ended September 30 2020 2019 2020 2019 Revenues $ 10,727 $ 8,902 $ 26,530 $ 23,616 Operating expenses: Cost of revenues 820 974 2,370 2,755 Engineering and product development 672 617 2,277 1,777 Sales and marketing 2,116 2,345 7,283 6,626 General and administrative 1,564 1,855 4,634 4,798 Total operating expenses 5,172 5,791 16,564 15,956 Income from operations 5,555 3,111 9,966 7,660 Interest income (expense) 2 (2) 5 — Other income (expense) 38 (1) 64 (3) Other expense 40 (3) 69 (3) Pre-tax net income $ 5,595 $ 3,108 $ 10,035 $ 7,657 Income tax provision (benefit) 729 (4,671) 1,421 (4,594) Net income 4,866 7,779 8,614 12,251 Net income per share, basic $ 0.74 $ 1.20 $ 1.31 $ 1.91 Weighted average number of shares used in computing basic income per share 6,578,808 6,492,501 6,553,522 6,410,588 Net income per share, diluted $ 0.61 $ 0.96 $ 1.07 $ 1.51 Weighted average number of shares used in computing diluted income per share 8,038,513 8,108,053 8,046,759 8,121,996 See accompanying notes to unaudited condensed financial statements. 1 Semler Scientific, Inc. (In thousands of U.S. Dollars, except share and per share data) (Unaudited) September 30, (unaudited) September 30, December 31, 2020 2019 Assets Current Assets: Cash $ 16,793 $ 7,741 Trade accounts receivable, net of allowance for doubtful accounts of $56 and $36 respectively 3,455 3,486 Prepaid expenses and other current assets 1,530 216 Total current assets 21,778 11,443 Assets for lease, net 1,802 2,079 Property and equipment, net 258 249 Notes receivable 500 — Other non-current assets 432 15 Long-term deferred tax assets 3,277 4,501 Total assets $ 28,047 $ 18,287 Liabilities and Stockholders’ Equity Current liabilities: Accounts payable $ 336 $ 338 Accrued expenses 4,277 3,914 Deferred revenue 960 955 Other short-term liabilities 78 — Total current liabilities 5,651 5,207 Long-term liabilities: Other long-term liabilities 345 7 Total long-term liabilities 345 7 Stockholders’ equity: Common stock, $0.001 par value; 50,000,000 shares authorized; 6,640,833, and 6,556,221 shares issued, and 6,615,833 and 6,531,221 shares outstanding (treasury shares of 25,000, and 25,000, respectively) 7 7 Additional paid-in capital 19,764 19,400 Retained earnings (accumulated deficit) 2,280 (6,334) Total stockholders’ equity 22,051 13,073 Total liabilities and stockholders’ equity $ 28,047 $ 18,287 See accompanying notes to unaudited condensed financial statements. 2 Semler Scientific, Inc. Statements of (In thousands of U.S. Dollars, except share and per share data) For the Three Months Ended September 30, 2019 Common Stock Treasury Stock Additional Common Stock Paid-In Accumulated Total Stockholder’s Shares Issued Amount Shares Amount Capital Deficit Equity Balance at June 30, 2019 6,484,414 $ 6 (25,000) $ 0 $ 23,161 $ (16,946) $ 6,221 Warrant Exercises 13,670 0 0 0 0 0 0 Stock Option Exercises 54,832 1 0 0 15 0 16 Stock-based Compensation 0 0 0 0 86 0 86 Net income 0 0 0 0 0 7,779 7,779 Balance at September 30, 2019 6,552,916 $ 7 (25,000) $ 0 $ 23,262 $ (9,167) $ 14,102 For the Three Months Ended September 30, 2020 Common Stock Treasury Stock Additional Common Stock Paid-In Retained Earnings / Total Stockholder’s Shares Issued Amount Shares Amount Capital (Accumulated Deficit) Equity Balance at June 30, 2020 6,588,176 $ 7 (25,000) $ 0 $ 19,598 $ (2,586) $ 17,019 Employee Stock Grant 641 0 0 0 0 0 0 Stock Option Exercises 52,016 0 0 0 104 0 104 Stock-based Compensation 0 0 0 0 62 0 62 Net income 0 0 0 0 0 4,866 4,866 Balance at September 30, 2020 6,640,833 $ 7 (25,000) $ 0 $ 19,764 $ 2,280 $ 22,051 For the Nine Months Ended September 30, 2019 Common Stock Treasury Stock Additional Common Stock Paid-In Accumulated Total Stockholder’s Shares Issued Amount Shares Amount Capital Deficit Equity Balance at December 31, 2018 6,349,985 $ 6 (25,000) $ 0 $ 25,608 $ (21,418) $ 4,196 Warrant Re-purchase 0 0 0 0 (2,687) 0 (2,687) Warrant Exercises 36,197 0 0 0 0 0 0 Stock Option Exercises 166,734 1 0 0 59 0 60 Stock-based Compensation 0 0 0 0 282 0 282 Net income 0 0 0 0 0 12,251 12,251 Balance at September 30, 2019 6,552,916 $ 7 (25,000) $ 0 $ 23,262 $ (9,167) $ 14,102 For the Nine Months Ended September 30, 2020 Common Stock Treasury Stock Additional Common Stock Paid-In Retained Earnings / Total Stockholder’s Shares Issued Amount Shares Amount Capital (Accumulated Deficit) Equity Balance at December 31, 2019 6,556,221 7 (25,000) 0 19,400 (6,334) 13,073 Employee Stock Grant 641 0 0 0 0 0 0 Stock Option Exercises 83,971 0 0 0 174 0 174 Stock-based Compensation 0 0 0 0 190 0 190 Net income 0 0 0 0 0 8,614 8,614 Balance at September 30, 2020 6,640,833 $ 7 (25,000) $ 0 $ 19,764 $ 2,280 $ 22,051 3 Semler Scientific, Inc. Condensed Statements of Cash Flows Unaudited (In thousands of U.S. Dollars) For the nine months ended September 30 2020 2019 CASH FLOWS FROM OPERATING ACTIVITIES: Net Income $ 8,614 $ 12,251 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Depreciation 412 470 Deferred tax expense 1,224 (4,709) Loss on disposal of assets for lease 178 159 Bad debt expense 43 42 Stock-based compensation expense 190 282 Changes in Operating Assets and Liabilities: Trade accounts receivable (13) (512) Prepaid expenses and other assets (1,315) (122) Other non-current assets (416) — Accounts payable (2) 389 Accrued expenses 264 109 Deferred revenue 5 734 Other current and non-current liabilities 416 — Net Cash Provided by Operating Activities 9,600 9,093 CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (103) (106) Notes receivable (400) — Purchase of assets for lease (219) (1,102) Net Cash Used in Investing Activities (722) (1,208) CASH FLOWS FROM FINANCING ACTIVITIES: Re-purchase of warrants — (2,687) Exercise of stock options 174 60 Net Cash Provided by (Used in) Financing Activities 174 (2,627) INCREASE IN CASH 9,052 5,258 CASH, BEGINNING OF PERIOD 7,741 3,284 CASH, END OF PERIOD $ 16,793 $ 8,542 See accompanying notes to unaudited condensed financial statements 4 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) 1. Basis of Presentation Semler Scientific, Inc., a Delaware corporation (“Semler” or “the Company”), prepared the unaudited interim financial statements included in this report in accordance with United States generally accepted accounting principles (“GAAP”) and applicable rules and regulations of the Securities and Exchange Commission (“SEC”) for interim financial reporting. Certain information and note disclosures normally included in the financial statements prepared in accordance with GAAP have been condensed or omitted pursuant to such rules and regulations. As such, the information included in this quarterly report on Form 10-Q should be read in conjunction with the audited financial statements and notes thereto included in the Company’s annual report on Form 10-K for the year ended December 31, On January 30, 2020, the World Health Organization (“WHO”) declared the recent novel coronavirus (COVID-19) outbreak a global health emergency, which prompted national, state and local governments to begin putting actions in place to slow the spread of COVID-19. In March 2020, the WHO classified the COVID-19 outbreak as a pandemic. The outbreak of COVID-19 resulted in travel restrictions, quarantines, “stay-at-home” and “shelter-in-place” orders and extended shutdown of certain businesses around the world. While restrictions began to ease in the second quarter and activities began to resume, recent outbreaks could lead to restrictions being reimplemented. For the nine months ended September 30, 2020, the Company’s revenues, primarily from variable-fee licenses, were negatively impacted by the COVID-19 pandemic. For the three months ended September 30, 2020, the Company’s revenues, primarily from variable-fee licenses, rebounded to and even exceeded pre-COVID-19 levels. The extent and duration of the pandemic is unknown, and the future effects on the Company’s business are uncertain and difficult to predict. The Company is continuing to monitor the events and circumstances surrounding the COVID-19 pandemic, which may require adjustments to the Company’s estimates and assumptions in the future. Recently Issued Accounting Pronouncements Accounting Pronouncements Recently Adopted In In 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. The amendments in this ASU modify the disclosure requirements on fair value measurements removing the requirements to disclosure amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, the policy for timing of transfers between levels, and the valuation processes for Level 3 fair value measurements. In addition, it modified certain disclosures related to Level 3 fair value measurements and added additional disclosures regarding the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period. This update is effective for the Company’s annual periods beginning after December 15, 2019, Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) including interim periods within those fiscal years. The Company adopted the new standard on January 1, 2020 and determined that the adoption of this this new accounting guidance did not have a material impact on its financial statements. Accounting Pronouncements Not Yet Adopted In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“Topic 326”). This ASU requires timelier recording of credit losses on loans and other financial instruments held. Instead of reserves based on a current probability analysis, Topic 326 requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. All organizations will now use forward-looking information to better inform their credit loss estimates. Topic 326 requires enhanced disclosures regarding significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio. These disclosures include qualitative and quantitative requirements that provide information about the amounts recorded in the financial statements. In addition, Topic 326 amends the accounting for credit losses on available-for-sale debt securities and purchased financial assets with credit deterioration. In April 2019, the FASB issued In In In March 2020, FASB issued ASU No. 2020-03, Codification Improvements to Financial Instruments. This ASU improves and clarifies various financial instruments topics, including In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. This ASU provides optional expedient and exceptions for applying generally accepted accounting principles to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. In response to the concerns about structural risks of interbank offered rates and, particularly, the risk of cessation of the London Interbank Offered Rate, regulators in several jurisdictions around the world have undertaken reference rate reform initiatives to identify alternative reference rates that are more observable or transaction-based and less susceptible to manipulation. The ASU provides companies with optional guidance to ease the potential accounting burden associated with transitioning away from reference rates that are expected to 6 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) be discontinued. The ASU can be adopted no later than December 1, 2022, with early adoption permitted. The Company has not yet adopted this ASU and is evaluating the effect of adopting this new accounting guidance. 2. Variable-fee Revenue The Company recognizes variable-fee licenses (i.e., fee per test) and sales of hardware equipment and accessories in accordance with Topic 606. Total fees from variable-fee licenses represent approximately $4,088 and $2,660 of revenues for the three months ended September 30, 2020 and 2019, respectively. Total fees from variable-fee licenses represent approximately $7,080 and $6,166 for the nine months ended September 30, 2020 and 2019, respectively. Total sales of hardware and equipment accessories represent approximately $332 and $291 of revenues for the three months ended September 30, 2020 and 2019, respectively. Total sales of hardware and equipment accessories represent approximately $732 and $842 of revenues for the nine months ended September 30, 2020 and 2019, respectively. Essentially all of the variable-fee licenses are with large healthcare organizations. The remainder of the revenue is earned from leasing the Company's testing product for a fixed fee, which is not subject to Topic 606. 3. Assets for Lease, net The Company enters into contracts with customers for the Company’s QuantaFlo® product. The Company has determined these contracts meet the definition of a lease under Topic 842. The lease portfolio primarily consists of operating leases that are short-term in nature (monthly, quarterly or one year, all of which have renewal options). The assets associated with these leasing arrangements are identified below as assets for lease. During the three months ended September 30, 2020 and 2019, the Company recognized approximately $6,307 and $5,951, respectively, in lease revenues related to these arrangements. During the nine months ended September 30, 2020 and 2019, the Company recognized approximately $18,718 and $16,608, respectively, in lease revenues related to these arrangements, which is included in Revenues on the Condensed Statements of Income. Assets for lease consist of the following: September 30, December 31, 2020 2019 $ 3,272 $ 3,374 (1,470) (1,295) $ 1,802 $ 2,079 Depreciation expense amounted to 4. Property and Equipment, net Capital assets consist of the following: September 30, December 31, 2020 2019 $ 739 $ 636 (481) (387) $ 258 $ 249 7 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) Depreciation expense amounted to Accrued expenses consist of the following: September 30, December 31, 2020 2019 $ 2,953 $ 2,803 Accrued taxes 875 378 449 733 $ 4,277 $ 3,914 6. Concentration of Credit Risk Credit risk is the risk of loss from amounts owed by the financial counterparties. Credit risk can occur at multiple levels; as a result of broad economic conditions, challenges within specific sectors of the economy, or from issues affecting individual companies. Financial instruments that potentially subject the Company to credit risk consist of cash and accounts receivable. The Company maintains cash with major financial institutions. The Company’s cash consists of bank deposits held with banks that, at times, exceed federally insured limits. The Company limits its credit risk by dealing with counterparties that are considered to be of high credit quality and by performing periodic evaluations of the relative credit standing of these financial institutions. Management periodically monitors the creditworthiness of its customers and believes that it has adequately provided for any exposure to potential credit loss. For the three months ended September 30, As of December 31, 7. Commitments and Contingencies Facilities Leases The Company recognized facilities lease expenses of On July 31, 2020, the Company entered into a 61-month lease agreement for office space to use, as necessary, for office administration, lab space and assembly and storage purposes, located in Santa Clara, California. The Company took possession of the leased office space in September 2020, and the lease is effective through September 30, 2025. The following table summarizes the future 8 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) minimum rental payments required under operating leases that had initial or remaining non-cancelable lease terms greater than one year as of September 30, 2020: Total October 2020 through December 2020 $ 21 2021 85 2022 87 2023 90 2024 93 2025 71 Thereafter — Total undiscounted future minimum payments 447 Less: present value discount (28) Total lease liabilities 419 Lease expense in excess of cash payments (7) Total right of use (“ROU”) asset $ 412 As of September 30, 2020, the Company’s ROU asset was $412, which is recorded on the Company’s balance sheet as other current assets. The Company’s current maturities of operating lease liabilities were $75, and the Company’s noncurrent lease liabilities were $345, which are recorded on the Company’s balance sheet as other short-term liabilities and other long-term liabilities, respectively. During the three and nine months ended September 30, 2020, the Company paid $0 in operating leases reflected as a reduction in operating cash flows. Indemnification Obligations The Company enters into agreements with customers, partners, lenders, consultants, lessors, contractors, sales representatives and parties to certain transactions in the ordinary course of the Company’s business. These agreements may require the Company to indemnify the other party against third party claims alleging that its product infringes a patent or copyright. Certain of these agreements require the Company to indemnify the other party against losses arising from: a breach of representations or covenants, claims relating to property damage, personal injury or acts or omissions of the Company, its employees, agents or representatives. The Company has also agreed to indemnify the directors and certain of the officers and employees in accordance with the by-laws of the Company. These indemnification provisions will vary based upon the nature and terms of the agreements. In many cases, these indemnification provisions do not contain limits on the Company’s liability, and the occurrence of contingent events that will trigger payment under these indemnities is difficult to predict. As a result, the Company cannot estimate its potential liability under these indemnities. The Company believes that the likelihood of conditions arising that would trigger these indemnities is remote and, historically, the Company The Company’s stock-based compensation program is designed to attract and retain employees while also aligning 9 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) on (and including) January 1, 2024, in an amount equal to 4% of the total number of shares of common stock outstanding on December 31st of the preceding calendar year. The Company’s Board of Directors may act prior to January 1st of a given year to provide that there will be no January 1st increase in the Share Reserve for such year or that the increase in the Share Reserve for such year will be a lesser number of shares of common stock than would otherwise occur. On January 1, 2020. In light of stockholder approval of the 2014 Plan, the Company no longer grants equity awards under the 2007 Plan. As of September 30, Restricted Stock The Company granted 641 shares of restricted stock to an employee in the three and nine months ended September 30, 2020. StockOptions Aggregate intrinsic value represents the difference between the closing market value as of September 30, Options Outstanding Weighted Number of Weighted Average Stock Average Remaining Aggregate Options Exercise Contractual Intrinsic Value Outstanding Price Term (In Years) (in thousands) Balance, January 1, 2020 1,581,582 $ 3.23 5.86 $ 70,827 Options exercised (85,226) 2.77 — — Balance, September 30, 2020 1,496,356 $ 3.25 5.15 $ 75,023 Exercisable as of September 30, 2020 1,447,502 $ 3.14 5.08 $ 72,741 The total compensation cost related to unvested stock option awards not yet recognized was The Company has recorded an expense of$ Three months ended September 30, Nine months ended September 30, 2020 2019 2020 2019 Cost of Revenue $ — $ 1 $ — $ 1 Engineering and Product Development — 2 — 14 Sales and Marketing — 7 — 39 General and Administrative 62 76 190 228 Total $ 62 $ 86 $ 190 $ 282 10 Semler Scientific, Inc. Basic earnings per share (“EPS”) represent net income attributable to common stockholders divided by the weighted average number of common shares outstanding during the measurement period. Diluted EPS represents net income attributable to common stockholders divided by the weighted average number of common shares outstanding during the measurement period while also giving effect to all potentially dilutive common shares that were outstanding during the period using the treasury stock method. Basic and diluted EPS is calculated as follows: Three months ended September 30, 2020 2019 Shares Net Income EPS Shares Net Income EPS Basic 6,578,808 $ 4,866 $ 0.74 6,492,501 $ 7,779 $ 1.20 70,291 0 155,490 0 1,389,414 0 1,460,062 0 Diluted 8,038,513 $ 4,866 $ 0.61 8,108,053 $ 7,779 $ 0.96 Nine months ended September 30, 2020 2019 Shares Net Income EPS Shares Net Income EPS Basic 6,553,522 $ 8,614 $ 1.31 6,410,588 $ 12,251 $ 1.91 69,682 0 190,144 0 1,423,556 0 1,521,264 0 Diluted 8,046,759 $ 8,614 $ 1.07 8,121,996 $ 12,251 $ 1.51 11. Exclusive Distribution Agreement 11 Semler Scientific, Inc. Notes to Condensed Financial Statements Unaudited (In thousands of U.S. Dollars, except share and per share data) In September 2020, the Company entered into an agreement to exclusively market and distribute a new product line in the United States, including Puerto Rico, for a privately-held company. Under this distribution agreement, the Company agreed to purchase $1,200 of product inventory. The 12. Note Receivable In September 2020, the Company acquired a $500 promissory note from a privately-held company in 13.Subsequent Events Following the In October 2020, the Company acquired a convertible note in a third privately-held company in a new product area for a purchase price of $58, which note converted into shares of preferred stock concurrent with the Company’s purchase of additional shares of preferred stock for $250. Subsequently, the Company acquired a $1,500 convertible promissory note, which is convertible into shares of preferred stock, and warrants to purchase shares of common stock of this third privately-held company. The Company 12 Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis should be read together with our condensed unaudited financial statements and the related notes appearing elsewhere in this quarterly report on Form 10-Q and with the audited financial statements and notes for the fiscal year ended December 31, Overview We are In the three months ended September 30, Recent Developments In September 2020, we entered into an In September 2020, we acquired a $500,000 promissory note from a second privately-held company in a new 13 In October 2020, we acquired a convertible note in a third privately-held company in a new product area for a purchase price of $58,000, which note converted into shares of preferred stock concurrent with our purchase of additional shares of preferred stock for $250,000. Subsequently, we acquired a $1,500,000 convertible promissory note, which is convertible into shares of preferred stock, and warrants to purchase shares of common stock of this third privately-held company. We funded $1,400,000 of the note, and the remaining $100,000 was retained for expense reimbursement. We Results of Operations Three Months Ended September 30, Revenues We had revenues of Revenues from fees for vascular testing products are recognized monthly for each unit installed with a customer, Operating expenses We had total operating expenses of Cost of revenues We had cost of revenues of Engineering and product development expense We had engineering and product development expense of 14 Sales and marketing expense We had sales and marketing expense of $2,116,000 for the three months ended September 30, 2020, a decrease of $229,000, or 10%, compared to $2,345,000 in the same period of the prior year. The decrease was primarily due to lower travel expenses. As a percentage of revenues, sales and marketing expense decreased to 20% in the third quarter of 2020, as compared to 26% in the prior year period. General and administrative expense We had general and administrative expense of Other income/expense We had other income of $40,000 for the three months ended September 30, 2020, compared to other expense of $3,000 in the same period of the prior year. The increase was primarily due to miscellaneous income and interest income, partially offset by credit card merchant fees. Pre-tax net income For the Income tax expense (benefit) We had income tax expense of Net income For the foregoing reasons, we had net income of Nine Months Ended September 30, Revenues We had revenues of Revenues from fees for vascular testing products are recognized monthly for each unit installed with a customer, 15 Operating expenses We had total operating expenses of Cost of revenues We had cost of revenues of Engineering and product development expense We had engineering and product development expense of Sales and marketing expense We had sales and marketing expense of General and administrative expense We had general and administrative expense of Other income/expense We had other income of $69,000 for the nine months ended September 30, 2020, compared to other expense of $3,000 in the same period of the prior year. The increase was primarily due to miscellaneous income and interest income, partially offset by credit card merchant fees. Pre-tax net income For the 16 Income tax expense /benefit We had income tax expense of $1,421,000 for the nine months ended September 30, 2020, compared to $4,594,000 income tax benefit in the same period of the prior year. The Net income For the foregoing reasons, we had net income of Liquidity and Capital Resources We had Our cash is held in a variety of non-interest bearing bank accounts. We may also hold interest-bearing instruments subject to investment guidelines allowing for holdings in U.S. government and agency securities, corporate securities, taxable municipal bonds, commercial paper and money market accounts. In addition, we may also choose to invest some of our cash resources in other entities that may have complementary technologies or product offerings, such as our recent decision to acquire inventory for distribution in the United States, including Puerto Rico, of a new product line offering, as well as make two minority investments in other privately-held companies in new product areas. Operating activities We generated $9,600,000 of net cash from operating activities for the nine months ended September 30, Investing activities We used $722,000 of net cash in investing activities for the nine months ended September 30, 2020, which reflects funding of notes receivable of $400,000, purchases of assets for lease of $219,000 and fixed asset purchases of $103,000 to support our growing business. We used $1,208,000 of net cash in investing activities for the nine months ended September 30, 2019, which reflects purchases of assets for lease of $1,102,000 and fixed asset purchases of $106,000 to support our growing business. Financing activities We $174,000. We used $2,627,000 17 Off-Balance Sheet Arrangements As of each of September 30, Commitments and Contingencies As of each of September 30, Item 3. Quantitative and Qualitative Disclosures About Market Risk. Not applicable. Item 4. Controls and Procedures. Disclosure Controls and Procedures We maintain disclosure controls and procedures that are designed to ensure material information required to be disclosed in our reports that we file or submit under the Securities Exchange Act of 1934, as amended, or the Exchange Act, is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance, as appropriate, to allow timely decisions regarding required financial disclosure. In designing and evaluating the disclosure controls and procedures, Under the supervision of and with the participation of our We previously identified the following material weaknesses in internal control over financial reporting as of the 18 Each of the Changes in Internal Control over Financial Reporting None. Not applicable. Item 2. Unregistered Sales of Equity Securities and Use of Proceeds. None. Item 3. Defaults None. Item 4. Mine Safety Disclosures. Not applicable. Not applicable. 19 Exh. No. Exhibit Name 31.1 Rule 13a-14(a) Certification of Principal Executive Officer of Registrant 31.2 Rule 13a-14(a) Certification of Principal Financial Officer of Registrant 32.1 101.INS XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document. 101.SCH Inline XBRL Taxonomy Extension Schema 101.CAL Inline XBRL Taxonomy Extension Calculation Linkbase 101.DEF Inline XBRL Taxonomy Extension Definition Linkbase 101.LAB Inline XBRL Taxonomy Extension Label Linkbase 101.PRE Inline XBRL Taxonomy Extension Presentation Linkbase 104 The cover page from Semler Scientific's Quarterly Report on Form 10-Q for the three months ended September 30, 2020 is formatted in Inline XBRL and it is contained in Exhibit 101 Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. November 6, SEMLER SCIENTIFIC, INC. By: /s/ Douglas Murphy-Chutorian, M.D. Douglas Murphy-Chutorian, M.D. Chief Executive Officer By: /s/ Andrew B. Weinstein Andrew B. Weinstein Senior Vice President, Finance and Accounting 21 (Unaudited) (Unaudited) For the three months ended September 30 For the nine months ended September 30 2019 2018 2019 2018 Revenues $ 8,902 $ 5,579 $ 23,616 $ 15,526 Operating expenses: Cost of revenues 974 615 2,755 1,999 Engineering and product development 617 587 1,777 1,443 Sales and marketing 2,345 1,798 6,626 5,283 General and administrative 1,855 1,033 4,798 2,908 Total operating expenses 5,791 4,033 15,956 11,633 Income from operations 3,111 1,546 7,660 3,893 Interest expense (2 ) (1 ) - (57 ) Related party interest expense - (74 ) - (206 ) Other expense (1 ) (3 ) (3 ) (4 ) Other expense (3 ) (78 ) (3 ) (267 ) Income before income taxes 3,108 1,468 7,657 3,626 Income tax (benefit) provision (4,671 ) - (4,594 ) - Net income $ 7,779 $ 1,468 $ 12,251 $ 3,626 Net income per share: Basic $ 1.20 $ 0.24 $ 1.91 $ 0.60 Diluted $ 0.96 $ 0.19 $ 1.51 $ 0.48 Weighted average number of shares used in computing: basic and diluted income per share Basic 6,492,501 6,086,489 6,410,588 5,998,460 Diluted 8,108,053 7,927,788 8,121,996 7,611,961 December 31, 2019 2018 Assets Current Assets: Cash $ 8,542 $ 3,284 Trade accounts receivable, net of allowance for doubtful accounts of $36 and $52, respectively 3,271 2,801 Prepaid expenses and other current assets 274 153 Total current assets 12,087 6,238 Assets for lease, net 1,826 1,243 Property and equipment, net 220 223 Long-term deposits 15 15 Long-term deferred tax assets 4,709 - Total assets $ 18,857 $ 7,719 Liabilities and Stockholders' Equity Current liabilities: Accounts payable $ 669 $ 280 Accrued expenses 2,909 2,797 Deferred revenue 1,169 435 Total current liabilities 4,747 3,512 Long-term liabilities: Deferred rent 8 11 Total long-term liabilities 8 11 Stockholders' equity: Common stock, $0.001 par value; 50,000,000 shares authorized; 6,552,916 and 6,349,985 shares issued, and 6,527,916 and 6,324,985 outstanding (treasury shares of 25,000 and 25,000), respectively 7 6 Additional paid-in capital 23,262 25,608 Accumulated deficit (9,167 ) (21,418 ) Total stockholders' equity 14,102 4,196 Total liabilities and stockholders' equity $ 18,857 $ 7,719 Stockholders'Stockholders’ Equity (Deficit) (InUnaudited For the Three Months Ended September 30, 2018 Common Stock Treasury Stock Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Total
Stockholder's
Equity Balance at June 30, 2018 6,048,397 $ 6 (25,000 ) $ - $ 24,484 $ (24,274 ) $ 216 Issuance of Common Stock 12,943 - - - 294 - 294 Warrant Exercises 26,139 - - - - - - Stock Option Exercises 110,815 - - - 195 - 195 Stock-based Compensation - - - - 139 - 139 Net income for three months ended September 30, 2018 - - - - - 1,468 1,468 Balance at September 30, 2018 6,198,294 $ 6 (25,000 ) $ - $ 25,112 $ (22,806 ) $ 2,312 For the Three Months Ended September 30, 2019 Common Stock Treasury Stock Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Total
Stockholder's
Equity Balance at June 30, 2019 6,484,414 $ 6 (25,000 ) $ - $ 23,161 $ (16,946 ) $ 6,221 Warrant Exercises 13,670 - - - - - - Stock Option Exercises 54,832 1 - - 15 - 16 Stock-based Compensation - - - - 86 - 86 Net income for three months ended September 30, 2019 - - - - - 7,779 7,779 Balance at September 30, 2019 6,552,916 $ 7 (25,000 ) $ - $ 23,262 $ (9,167 ) $ 14,102 See accompanying notes to unaudited condensed financial statements.For the Nine Months Ended September 30, 2018 Common Stock Treasury Stock Total Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Stockholder's
Equity /
(Deficit) Balance at December 31, 2017 5,902,244 $ 6 (25,000 ) $ - $ 23,843 $ (26,432 ) $ (2,583 ) Issuance of Common Stock 12,943 - - - 294 - 294 Warrant Exercises 66,914 - - - 64 - 64 Stock Option Exercises 216,193 - - - 440 - 440 Stock-based Compensation - - - - 471 - 471 Net income for nine months ended September 30, 2018 - - - - - 3,626 3,626 Balance at September 30, 2018 6,198,294 $ 6 (25,000 ) $ - $ 25,112 $ (22,806 ) $ 2,312 For the Nine Months Ended September 30, 2019 Common Stock Treasury Stock Shares
Issued Common
Stock
Amount Shares Amount Additional
Paid-In
Capital Accumulated
Deficit Total
Stockholder's
Equity Balance at December 31, 2018 6,349,985 6 (25,000 ) - 25,608 (21,418 ) 4,196 Warrant Repurchase - - - - (2,687 ) - (2,687 ) Warrant Exercises 36,197 - - - - - - Stock Option Exercises 166,734 1 - - 59 - 60 Stock-based Compensation - - - - 282 - 282 Net income for nine months ended September 30, 2019 - - - - - 12,251 12,251 Balance at September 30, 2019 6,552,916 $ 7 (25,000 ) $ - $ 23,262 $ (9,167 ) $ 14,102 See accompanying notes to unaudited condensed financial statements.4 (Unaudited)
Nine months ended September 30 2019 2018 CASH FLOWS FROM OPERATING ACTIVITIES: Net income $ 12,251 $ 3,626 Reconciliation of Net Income to Net Cash Provided by Operating Activities: Amortization of debt discount - 22 Accretion of non-cash interest - 200 Depreciation 470 373 Deferred income tax (4,709 ) - Loss on disposal of property and equipment - 2 Loss on disposal of assets for lease 159 150 Bad debt expense 42 39 Stock-based compensation expense 282 470 Changes in Operating Assets and Liabilities: Trade accounts receivable (512 ) (1,165 ) Prepaid expenses and other assets (122 ) (60 ) Accounts payable 389 (237 ) Accrued expenses 109 (609 ) Deferred revenue 734 (160 ) Net Cash Provided by Operating Activities 9,093 2,651 CASH FLOWS FROM INVESTING ACTIVITIES: Additions to property and equipment (106 ) (131 ) Proceeds from disposal of property and equipment - 1 Purchase of assets for lease, net (1,102 ) (323 ) Net Cash Used in Investing Activities (1,208 ) (453 ) CASH FLOWS FROM FINANCING ACTIVITIES: Repurchase of warrants (2,687 ) - Exercise of warrants - 64 Exercise of stock options 60 440 Payments of loans payable - (1,072 ) Net Cash Used in Financing Activities (2,627 ) (568 ) INCREASE IN CASH 5,258 1,630 CASH, BEGINNING OF PERIOD 3,284 1,457 CASH, END OF PERIOD $ 8,542 $ 3,087 Cash paid for interest $ - $ 192 Retirement of related party loans payable through common stock issuance $ - $ 294 5Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)1.Basis of Presentation20182019 filed with the SEC on March 7, 20199, 2020 (the “Annual Report”). In the opinion of management, these financial statements include all adjustments (consisting of normal recurring adjustments) necessary for a fair statement of the financial position, results of operations and cash flows for the periods presented. The results of operations for the interim periods shown in this report are not necessarily indicative of the results that may be expected for any future period, including the full year.May 2014,November 2019, the Financial Accounting Standards Board (“FASB”) issued Accounting StandardStandards Update (“ASU”) No. 2014-09,2019-08 – Compensation – Stock Compensation (Topic 718) and Revenue from Contracts with Customers (“ASU No. 2014-09”)Customer (Topic 606). The amendment in this ASU provides guidanceamendments on the revenue recognition to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The core principle of this update provides guidancerequire that an entity measure and classify share-based payment awards granted to identify the performance obligations under the contract(s) with a customer and how to allocateby applying the guidance in Topic 718. The amount recorded as a reduction in the transaction price toshould be based on the performance obligations ingrant-date fair value of the contract. It further provides guidance to recognize revenue when (or as) the entity satisfies a performance obligation.share-based payment award. This standard replaced most existing revenue recognition guidance. On August 8, 2015,is effective for the FASB issued ASU 2015-14, which deferred the effective date of ASU No. 2014-09 by one year, and permits early adoption as long as the adoption date is not before the original public entity effective date. Since the issuance of ASU 2014-09, the FASB has issued several amendments that clarify certain points,Company’s annual periods beginning after December 15, 2019, including ASU 2016-08, Principal versus Agent Considerations (Reporting Revenue Gross versus Net), ASU 2016-10, Revenue from Contracts with Customers (Topic 606), Identifying Performance Obligations and Licensing (“Topic 606”), ASU 2016-11, Rescission of SEC Guidance Because of Accounting Standards Updates 2014-09 and 2014-16 Pursuant to Staff Announcements at the March 3, 2016 Emerging Issues Task Force Meeting, and ASU 2016-12, Narrow-Scope Improvements and Practical Expedients, and ASU No. 2016-20, Technical Corrections and Improvements to Topic 606. The updated revenue standard allows two methods of adoption: (1) retrospectively to each prior period presented (“full retrospective method”), or (2) retrospectively with the cumulative effect recognized in retained earnings as of the date of adoption (“modified retrospective method”). The new standard further requires new disclosures about contracts with customers, including the significant judgments the company has made when applying the guidance.interim periods within those fiscal years. The Company adopted the new standard effectiveon January 1, 2019, using the modified retrospective method. The Company2020 and determined that the adoption of this new standardaccounting guidance did not have a material impact on its financial statements.Topic 606 affects revenue recognition for the Company’s variable license fee contracts, which represents approximately $2,660 and $1,375 of revenues for the three-month periods ended September 30, 2019 and 2018, respectively, and approximately $6,166 and $3,384 of revenues for the nine-month periods ended September 30, 2019 and 2018, respectively. Essentially all of the variable license fee contracts are with large healthcare organizations. The remainder of the revenue is earned from leasing the Company's testing product for a fixed monthly fee, which is not subject to Topic 606. It was determined that the impact of the new standard has no effect on the way revenue was currently being recognized. Reusable hardware equipment or accessories may be provided to a customer for a set price and then use of the associated software is billed to the customer monthly based on volume of use. Under this scenario, revenue is recognized when and only when the customer uses the product. The Company is rendering a service and recognizes revenue in direct proportion to how much service is rendered. The sale of the equipment or accessories is recognized as hardware sales upon shipment to the customer. The initial contract is for a specified time period with automatic renewal each period thereafter until canceled. In case there is a violation of any term of the contract, the Company may deactivate the service remotely, so that the customer cannot continue to use the product.6Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)Accounting Pronouncements Not Yet AdoptedIn January 2016, the FASB issued ASU No. 2016-02, Leases (Topic 842) (“ASU No. 2016-02”). Under the new guidance in ASU No. 2016-02, lessees will be required to recognize the following for all leases (with the exception of short-term leases) at the commencement date: 1) A lease liability, which is a lessee’s obligation to make lease payments arising from a lease, measured on a discounted basis; and 2) A right-of-use asset, which is an asset that represents the lessee’s right to use, or control the use of, a specified asset for the lease term. Under the new guidance, lessor accounting is largely unchanged, however, certain targeted improvements were made. ASU No. 2016-02 also simplifies the accounting for sale and leaseback transactions. Lessees (for capital and operating leases) and lessors (for sales-type, direct financing, and operating leases) must apply a modified retrospective transition approach for leases existing at, or entered into after, the beginning of the earliest comparative period presented in the financial statements. Lessees and lessors may not apply a full retrospective transition approach. The new standard also requires expanded disclosures regarding leasing arrangements. In JulyJune 2018, the FASB issued ASU No. 2018-11, Leases2018-07, Compensation—Stock Compensation (Topic 842)718): Targeted Improvements (“to Nonemployee Share-Based Payment Accounting. This ASU No. 2018-11”). ASU No. 2018-11 provides another transition method in additionexpands the scope of Topic 718 to the existing transition method by allowing entities to initiallyinclude share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the new leases standard at the adoption date and recognize a cumulative effect adjustmentrequirements of Topic 718 to the opening balance of retained earnings in the period of adoption. This ASU also provides furthernonemployee awards except for specific guidance on lessors accounting policy electioninputs to not separate non-lease components froman option pricing model and the associated lease components and limits thisattribution of costs. The ASU specifies that Topic 718 applies to circumstancesall share-based payment transactions in which the non-lease componenta grantor acquires goods or components otherwise wouldservices to be accounted for under the new revenue guidance and both (1) the timing and pattern of transfer are the sameused or consumed in a grantor’s own operations by issuing share-based payment awards. This standard is effective for the non-lease component(s) and associated lease component, and (2) the lease component, if accounted for separately, would be classified as a an operating lease. InCompany’s annual periods beginning after December 2018, the FASB issued ASU No. 2018-20, Leases (Topic 842): Narrow-Scope Improvements for Lessors. This ASU provide narrow scope improvements for lessor accounting by permitting lessors, as an accounting policy election, to treat certain sales taxes and other similar taxes as lessee costs, to exclude lessor costs paid by lessees directly to third parties from variable payments, and clarify the accounting by lessors for variable payments that related to both a lease component and a non-lease component. In January15, 2019, the FASB issued ASU No. 2019-01, Leases Codification Improvements, which reinstates the exception for lessors that are not manufacturers or dealers for determining fair value of the leased property as the underlying asset’s cost, clarifies the presentation on the statement of cash flows for sales type and direct financing leases for lessors that are depository and lending institutions and clarifies the transition disclosures related to accounting changes and error corrections in the year of adoption of the ASU.including interim periods within those fiscal years. The Company will adoptadopted the new standard on December 31, 2019 upon expiration of their status as an emerging growth company using the modified retrospective approach and the optional transition method under ASU No. 2018-11. The Company evaluated the impact of the new accounting standard on its lease contracts with customers and determined that there will be no impact to the accounting and revenue recognition under these lease contracts with customers. As for leases for which the Company is the lessee, management reviewed its lease obligationsJanuary 1, 2020 and determined that the Company generally does not enter into long-term lease obligations with the exception of its office leases. The Company is a lessee on certain real estate leases that will need to be reported as right of use assets and liabilities related to these leases in the Company’s financial statements on the date of adoption. The Company is in the process of determining the amounts to be recorded on adoption related to these leases and does not anticipate that adoption of this this new standard willaccounting guidance did not have a material impact on its financial statements.ASU2019-04 ASU No. 2019-04, Codification Improvements to Topic 326 Financial Instruments—Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, to introduce amendments which will affect the recognition and measurement of financial instruments, including derivatives and hedging. In May 2019, the FASB issued ASU No. 2019-05, Financial Instruments – Credit Losses (Topic 326); Targeted Transition Relief.Relief. The amendments in this ASU provide entities that have certain instruments within the scope of Subtopic 326-20 with an option to irrevocably elect the fair value option in Subtopic 825-10, applied on an instrument-by-instrument basis for eligible instruments upon adoption of Topic 326. This standard and related amendments are effective for the Company’s fiscal years beginning after December 15, 2019,2022, including interim periods within those fiscal years. The Company will adopt the new standard in the first quarter of fiscal year 2020.2023. The Company does not anticipate this new standard will have a material impact on its financial statements.June 2018,December 2019, the FASB issued ASU No. 2018-07, Compensation—Stock Compensation2019-12, Income Taxes (Topic 718)740): ImprovementsSimplifying the Accounting for Income Taxes, which simplifies the accounting for income taxes by removing certain exceptions to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”).the general principles for income taxes. This ASU expands the scope of Topic 718 to include share-based payment transactions for acquiring goods and services from nonemployees. An entity should apply the requirements of Topic 718 to nonemployee awards except for specific guidance on inputs to an option pricing model and the attribution of costs. The ASU specifies that Topic 718 applies to all share-based payment transactions in which a grantor acquires goods or services to be used or consumed in a grantor’s own operations by issuing share-based payment awards. This standardupdate is effective for the Company’s annual periods beginning after December 15, 2019,2020, including interim periods within those fiscal years. The Company will adopt the new standard in the first quarter of fiscal year 2020.2021. The Company does not anticipate this new standardupdate will have a material impact on its financial statements.7Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)August 2018,January 2020, the FASB issued ASU No. 2018-13, Fair Value Measurement2020-01, Investments-Equity Securities (Topic 820): Disclosure Framework—Changes to the Disclosure Requirements for Fair Value Measurement.321), Investments-Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815). The amendments in this ASU modifyclarify the disclosure requirements on fair value measurements removinginteraction between the requirementsaccounting for investments in equity securities, investment in equity method and certain derivatives instruments. The ASU is expected to disclosure amount ofreduce diversity in practice and reasons for transfers between Level 1 and Level 2increase comparability of the fair value hierarchy, the policyaccounting for timing of transfers between levels, and the valuation processes for Level 3 fair value measurements. In addition, it modified certain disclosures related to Level 3 fair value measurements and added additional disclosures regarding the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements and the changes in unrealized gains and losses for the period included in other comprehensive income for recurring Level 3 fair value measurements held at the end of the reporting period.these interactions. This updateASU is effective for the Company’s annual periodsfiscal years beginning after December 15, 2019,2021. The adoption of this ASU is not expected to have any impact on the Company's results of operations, cash flows or financial position.interim periods within those fiscal years.the current expected credit losses standard issued in 2016 (ASU No. 2016-13). The ASU includes seven different issues that describe the areas of improvement and the related amendments to GAAP, intended to make the standards easier to understand and apply by eliminating inconsistencies and providing clarifications. The amendments have different effective dates. The Company will adoptis evaluating the effect of adopting this new standard in the first quarter of fiscal year 2020. The Companyaccounting guidance, but does not anticipate this update toexpect adoption will have a material impact on its financial statements.2.Assets for Lease, net September 30,
2019 December 31,
2018 Assets for lease $ 3,047 $ 2,218 Less: accumulated depreciation (1,221 ) (975 ) Assets for lease, net $ 1,826 $ 1,243 $124$146 and $97$124 for the three months ended September 30, 20192020 and 2018,2019, respectively. Depreciation expense amounted to $361$318 and $296$361 for the nine months ended September 30, 20192020 and 2018,2019, respectively. Reduction to accumulated depreciation for returned items was $38$56 and $24$38 for the three months ended September 30, 20192020 and 2018,2019, respectively. Reduction to accumulated depreciation for returned items was $115$143 and $85$115 for the nine months ended September 30, 20192020 and 2018,2019, respectively. The Company recognized a loss on disposal of assets for lease in the amount of $62$54 and $43$62 for the three months ended September 30, 20192020 and 2018,2019, respectively. The Company recognized a loss on disposal of assets for lease in the amount of $159$178 and $150$159 for the nine months ended September 30, 20192020 and 2018,2019, respectively.3. September 30,
2019 December 31,
2018 Capital assets $ 563 $ 457 Less: accumulated depreciation (343 ) (234 ) Capital assets, net $ 220 $ 223 $38$32 and $27$38 for the three months ended September 30, 20192020 and 2018,2019, respectively. Depreciation expense amounted to $109$94 and $77$109 for the nine months ended September 30, 20192020 and 2018,2019, respectively.8Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)4.5. Accrued Expenses September 30,
2019 December 31,
2018 Compensation $ 2,344 $ 2,442 Accrued Taxes 185 81 Miscellaneous accruals 380 274 Total accrued expenses $ 2,909 $ 2,797 5.2018, two customers accounted for 51.8% and 22.2% of the Company’s revenue, respectively. For the nine months ended September 30, 2018, two customers accounted for 53.1% and 19.4% of the Company’s revenue, respectively. For the three months ended September 30, 2019, three3 customers accounted for 47.0%, 15.7% and 12.4% of the Company’s revenue,revenues, respectively. For the nine months ended September 30, 2019, three3 customers accounted for 50.7%, 12.9%, and 12.8% of the Company’s revenue,revenues, respectively. For the three months ended September 30, 2020, 2 customers accounted for 39.2% and 29.8% of the Company’s revenues. For the nine months ended September 30, 2020, 2 customers accounted for 47.2% and 20.4% of the Company’s revenues, respectively. As of December 31, 2018, two2019, 3 customers accounted for 43.5%55.9%, 17.6% and 40.4%12.0% of the Company’s accounts receivable, respectively. As of September 30, 2019, three2020, 3 customers accounted for 30.8%42.2%, 22.6%11.6% and 16.6%11.1% of the Company’s accounts receivable, respectively.The Company’s largest customer in terms of both revenues forand accounts receivable in the three months ended September 30, 2019 and accounts receivable as of September 30, 20192020 is a U.S. diversified healthcare company and its affiliated plans.2018, two2019, 2 vendors accounted for 11.0%15.9% and 10.8%14.1% of the Company’s accounts payable, respectively. As of September 30, 2019, four2020, 3 vendors accounted for 15.4%19.4%, 12.3%, 10.9%17.5%, and 10.3%13.0% of the Company’s accounts payable, respectively.6.$17$32 and $17 for the three months ended September 30, 20192020 and 2018,2019, respectively. The Company recognized facilities lease expenses of $51$67 and $52$51 for the nine months ended September 30, 20192020 and 2018,2019, respectively.hadhas not made any significant payment under such indemnification provisions. Accordingly, the Company has not recorded any liabilities relating to these agreements. In certain cases, the Company has recourse against third parties with respect to the aforesaid indemnities, and the Company believes it maintains adequate levels of insurance coverage to protect the Company with respect to potential claims arising from such agreements.9Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)7.Warrant Repurchase – Related PartyOn May 3, 2019, the Company entered into a Warrant Repurchase Agreement with the Murphy-Chutorian Family Trust U/D/T dated January 13, 1997, of which Douglas Murphy-Chutorian, M.D., the Company’s director and chief executive officer is co-Trustee with his spouse and of which he is a beneficiary. Pursuant to the warrant repurchase agreement, the Company repurchased a warrant to acquire 65,542 shares of the Company’s common stock held by the trust, which warrant had an exercise price equal to $4.50 per share and an expiration date of July 31, 2023, at an aggregate purchase price of $2,687. The purchase price reflects the difference between the aggregate exercise price of the warrant and the aggregate fair market value of the shares underlying the warrant, based on the last trade price of the Company’s common stock on May 3, 2019, the date of the warrant repurchase agreement. Following the warrant repurchase, the warrant was cancelled and is no longer issued and outstanding.8.Stock Option8. Stock Incentive Planemployees'employees’ interests with the interests of its stockholders. Stock options have been granted to employees under the stockholder-approved 2007 Key Person Stock Option Plan (“2007 Plan”) orand stock options and restricted stock have been granted to employees under the stockholder-approved 2014 Stock Incentive Plan (“2014 Plan”). Stockholder approval of the 2014 Plan became effective in September 2014. The 2014 Plan originally provided that the aggregate number of shares of common stock that may be issued pursuant to awards granted under the 2014 Plan may not exceed 450,000 shares (the “Share Reserve”), however in October 2015, the stockholders approved a 1,500,000 increase to the Share Reserve. In addition, the Share Reserve automatically increases on January 1st of each year, for a period of not more than 10 years, beginning on January 1st of the year following the year in which the 2014 Plan became effective and ending2015,2020, the Share Reserve increased by 188,640 shares due to the automatic 4% increase. On January 1, 2016, the Share Reserve increased by 204,943 shares due to the automatic 4% increase. On January 1, 2017, the Share Reserve increased by 204,943 shares due to the automatic 4% increase. On January 1, 2018, the Share Reserve increased by 235,090261,249 shares due to the automatic 4% increase. The Share Reserve is currently 2,783,616 shares as of September 30, 2019.2019,2020, 0 shares of an aggregate total of 407,500 shares were available for future stock-based compensation grants under the 2007 Plan and 996,9681,259,200 shares of an aggregate total of 2,783,616 shares were available for future stock-based compensation grants under the 2014 Plan.20192020 of the underlying common stock and the exercise price of outstanding, in-the-money options. A summary of the Company’s stock option activity and related information for the nine months ended September 30, 20192020 is as follows: Options Outstanding Number of
Stock Options
Outstanding Weighted
Average
Exercise Price Weighted
Average
Remaining
Contractual
Term (In Years) Aggregate
Intrinsic Value
(in thousands) Balance, January 1, 2019 1,761,447 $ 3.18 6.84 $ 55,000 Options exercised (176,365 ) 2.72 Balance, September 30, 2019 1,585,082 $ 3.23 6.11 $ 61,460 Exercisable as of September 30, 2019 1,451,359 $ 3.05 5.96 $ 56,535 10Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)$515$244 as of September 30, 2019.2020. The weighted average period over which the total unrecognized compensation cost related to these unvested stock awards will be recognized is 1.130.7 years.The weighted average fair value of There were 0 options granted during the three or nine months ended September 30, 2018 was $5.97 per share,2020 or an aggregate grant date fair value of $806. There were no options granted during the nine months ended September 30, 2019.On January 2, 2018, the Compensation Committee of the Company’s Board of Directors granted, and the full Board ratified, an option to acquire an aggregate of 125,000 shares under the 2014 Plan to the Company’s CEO. This option vests 25% on the one-year anniversary of the grant date and monthly thereafter for 36 months, such that the option is vested in full on the four-year anniversary of the grant date. On January 2, 2018, the Company’s Compensation Committee granted, and the full Board ratified, options to each of the then-seated non-employee Directors to acquire 5,000 shares, for an aggregate of 10,000 shares, under the 2014 Plan. These options vest on the one-year anniversary of their grant date. On February 28, 2018, the Compensation Committee of the Company’s Board of Directors accelerated the vesting on stock options issued to consultants such that all unvested shares were vested on that date. This resulted in a one-time expense of $49 during the three months ended March 31, 2018.Determining the Fair Value of Stock OptionsThe Company uses the Black-Scholes pricing model to determine the fair value of stock options. The fair value of each option grant is estimated on the date of the grant. There were no stock options granted during the nine months ended September 30, 2019. There were no stock options granted during the three months ended September 30, 2018. There were 135,000 stock options granted during the nine months ended September 30, 2018. The following assumptions for the periods presented were: Three months ended
September 30, Nine months ended
September 30, 2019 2018 2019 2018 Expected term (in years) - - - 5 Risk-free interest rate - % - % - % 2.02 % Expected volatility - % - % - % 0.99 % Expected dividend rate - % - % - % - % The assumptions are based on the following for each of the periods presented:Valuation Method — The Company estimates the fair value of its stock options using the Black-Scholes option pricing model.Expected Term — The Company estimates the expected term consistent with the simplified method identified by the SEC. The Company elected to use the simplified method because of its limited history of stock option exercise activity and its stock options meet the criteria of the “plain-vanilla” options as defined by the SEC. The simplified method calculates the expected term as the average of the vesting and contractual terms of the award.Volatility — The Company derives this number from the historical stock volatilities of the Company’s stock over a period approximately equal to the expected term of the options.Risk-free Interest Rate — The risk-free interest rate is based on median U.S. Treasury zero coupon issues with remaining terms similar to the expected term on the options.Expected Dividend— The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and therefore, used an expected dividend yield of zero in the valuation model.Forfeiture — Beginning in the first quarter of 2017, the Company implemented ASU 2016-09, and elected to true-up calculations at the time of forfeiture, rather than creating an estimate at the time of option issuance.8662 and $139$86 as it relates to stock-based compensation for the three months ended September 30, 20192020 and 2018,2019, respectively. The Company has recorded an expense of $190 and $282 and $470 as it relates to stock-based compensation for the nine months ended September 30, 20192020 and 2018,2019, respectively:11Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data) Three months ended
September 30, Nine months ended
September 30, 2019 2018 2019 2018 Cost of Revenue $ 1 $ 1 $ 1 $ 1 Engineering and Product Development 2 9 14 26 Sales and Marketing 7 23 39 74 General and Administrative 76 106 228 369 Total $ 86 $ 139 $ 282 $ 470 Three months ended September 30, 2019 2018 Shares Net Income EPS Shares Net Income EPS Basic EPS 6,492,501 $ 7,779 $ 1.20 6,086,489 $ 1,468 $ 0.24 Common stock warrants 155,490 - 354,420 - Common stock options 1,460,062 - 1,486,897 - Diluted EPS 8,108,053 $ 7,779 $ 0.96 7,927,788 $ 1,468 $ 0.19 Nine months ended September 30, 2019 2018 Shares Net Income EPS Shares Net Income EPS Basic EPS 6,410,588 $ 12,251 $ 1.91 5,998,460 $ 3,626 $ 0.60 Common stock warrants 190,144 - 308,529 - Common stock options 1,521,264 - 1,304,972 - Diluted EPS 8,121,996 $ 12,251 $ 1.51 7,611,961 $ 3,626 $ 0.48 ThereThe were no0 weighted average shares outstanding of common stock equivalents excluded from the computation of diluted net incomeloss per share for the three or nine months ended September 30, 20192020 and 2018. 2019.10.Income Tax BenefitCompany’s income tax provision (benefit) forCompany also agreed to certain minimum quotas of product inventory during the three and nine months ended September 30, 2019 and September 30, 2018 reflects its estimateterm of the effective tax rates expectedagreement and to make royalty payments ranging from 0% to 10% of net sales depending on the average net sales price of the distributed products. Unless early terminated in accordance with its terms, the exclusive distribution agreement will remain in full force and effect until December 31, 2024, and thereafter there is an option for this agreement to be applicableautomatically renewed for additional 4-year terms. In September 2020, the full year, adjustedCompany made a prepayment of $900 for any discrete events that areinventory to be delivered during the quarter ending December 31, 2020, which has been recorded in the periodcondensed balance sheet as prepaid expenses and other current assets.which they occur.a new product area. The estimates are re-evaluated each quarter basedCompany funded $400 of the note, and the remaining $100 was retained for expense reimbursement. This note receivable is recorded on the estimated tax expenseCompany’s balance sheet as of September 30, 2020. This note has an interest rate of 10%, has customary terms for default and fully matures upon the one-year anniversary of the issuance date. The Company expects to receive 0 payments on this note during the remainder of 2020 and full payment of $550 for the full year. Duringnote and interest upon maturity in 2021.three months ended September 30, 2019, management determined there was sufficient positive evidence that it was more likely than not thatnote receivable investment referred to in Note 12, in October 2020, the federalCompany made an investment in the equity securities of such privately-held company for 40,922 shares of the Company’s common stock.state net operating loss (“NOL”) carryforwards and other related deferred tax assets would be realized and therefore, released the valuation allowance against the deferred tax assets.recorded a tax benefitfunded $1,400 of approximately $4,671 and a tax provision of $0 for the three months ended September 30, 2019 and 2018, respectively. The Company recorded a tax benefit of approximately $4,594 and a tax provision of $0 for the nine months ended September 30, 2019 and 2018, respectively, representing effective tax rates of (60)% and 0%, respectively. The tax benefit during the three and nine months ended September 30, 2019 was primarily due to the release of valuation allowances of approximately $5,338.12Semler Scientific, Inc.Notes to Condensed Financial StatementsUnaudited(In thousands of U.S. Dollars, except share and per share data)The difference between the U.S. federal statutory tax rate of 21%note, and the Company’s effective tax rateremaining $100 was retained for expense reimbursement.132018,2019, and the information under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K filed with the SEC on March 7, 2019,9, 2020, or the Annual Report. This discussion contains forward-looking statements reflecting our current expectations that involve risks and uncertainties. See “Cautionary Note Regarding Forward-Looking Statements” for a discussion of the uncertainties, risks and assumptions associated with these statements. Actual results and the timing of events could differ materially from those discussed in our forward-looking statements as a result of many factors, including those set forth under “Risk Factors” in our Annual Report.Report and the ongoing COVID-19 pandemic.an emerging growtha company providing technology solutions to improve the clinical effectiveness and efficiency of healthcare providers. Our mission is to develop, manufacture and market innovative proprietary products and services that assist our customers in evaluating and treating chronic diseases. In 2011, we began commercializing our first patented and U.S. Food and Drug Administration, or FDA, cleared product, which measured arterial blood flow in the extremities to aid in the diagnosis of peripheral arterial disease, or PAD. In March 2015, we received FDA 510(k) clearance for the next generation version of our product, QuantaFlo™QuantaFlo®, which we began commercializing in August 2015. We believe our products and services position us to provide valuable information to our customer base, which in turn permits them to better guide patient care.2019,2020, we had total revenues of $10,727,000 and net income of $4,866,000, compared to total revenues of $8,902,000 and net income of $7,779,000 compared to total revenues of $5,579,000 and net income of $1,468,000 in the same period in 2018.2019. In the nine months ended September 30, 2019,2020, we had total revenues of $26,530,000 and net income of $8,614,000 compared to total revenues of $23,616,000 and net income of $12,251,000 compared to total revenues of $15,526,000 and net income of $3,626,000 in the same period in 2018.2019.Emerging Growth Company ElectionsThe JOBS Act provides that an emerging growth company,Late in the first quarter and into the second quarter of 2020, we experienced decreased test volumes due to COVID-19 related “social distancing” and other executive orders mandating “shelter-in-place” or similar restrictions, which limited patient visits by our customers. As such restrictions have been lifted around the country and non-emergency medical services have resumed in the third quarter of 2020, our business has returned to and even exceeded pre-COVID-19 levels. We experienced even higher test volumes as our company, can take advantagecustomers accelerated usage due to a backlog of untested patients. However, there is uncertainty that the recent roll-back in restrictions will be maintained. New, additional or different restrictions could be imposed, which could impact the usage of our product by our customers. Other customers who have fixed-fee licenses could decide to cancel their licenses if they are not able to use our device as frequently as they had anticipated in light of such restrictions.extended transition periodagreement to exclusively market and distribute a new product line in the United States, including Puerto Rico, for complying with new or revised accounting standards. This allows an emerging growth companya privately-held company. Under this distribution agreement, we agreed to delaypurchase $1,200,000 of product inventory. We also agreed to certain minimum quotas of product inventory during the adoption of these accounting standards until they would otherwise apply to private companies. We have elected to avail ourselves of this exemption. As a result, our financial statements may not be comparable to other public companies that comply with public company effective dates. In the future, we may elect to opt outterm of the extended periodagreement and to make royalty payments ranging from 0% to 10% of net sales depending on the average net sales price of the distributed products. Unless early terminated in accordance with its terms, the exclusive distribution agreement will remain in full force and effect until December 31, 2024, and thereafter there is an option for adoptingthis agreement to be automatically renewed for additional 4-year terms. In September 2020, we made a prepayment of $900,000 for inventory to be delivered during the fourth quarter of 2020.accounting standards. If we do so, we would need to disclose such decisionproduct area. We funded $400,000 of the note, and it would be irrevocable.the remaining $100,000 was retained for expense reimbursement. This note has an interest rate of 10%, has customary terms for default and fully matures upon the one-year anniversary of the issuance date. We expect to cease beingreceive no payments on this note during the remainder of 2020 and full payment of $550,000 for the note and interest upon maturity in 2021. Following this, in October 2020, we made an emerging growthinvestment in the equity securities of such privately-held company asfor 40,922 shares of December 31, 2019,our common stock. The shares were issued in reliance on the last dayexemption from registration requirements provided by Section 4(a)(2) of the fiscal year followingSecurities Act of 1933, as amended.fifth anniversary of our initial public offering.Factors Affecting Future Resultshave not identified any factorsinvested in these three private companies as they are developing products that have a recurring effect thatmay allow us to expand our current product offering beyond QuantaFlo® for PAD, in addition to our internal research and development efforts. Their products deal with better chronic disease management and may be used by primary care practitioners, are necessaryFDA-cleared or equivalent, produced positive clinical data and two of the three new products seek to understand period to period comparisons as appropriate, nor any one-time events that have an effect onimprove aspects or sequelae of the financials.metabolic syndrome.20192020 Compared to Three Months Ended September 30, 20182019$8,902,000$10,727,000 for the three months ended September 30, 2019,2020, an increase of $3,323,000,$1,825,000, or 60%21%, compared to $5,579,000$8,902,000 in the same period in 2018.2019. Our revenues are primarily from fees charged to customers for use of our vascular testing products and from salessale of accessories used with these products. We recognized revenues from fixed-fee licenses of $8,612,000 from fees for our vascular testing products for the three months endedSeptember 30, 2019,$6,307,000 an increase of $3,086,000$356,000, or 6%, compared to $5,526,000$5,951,000 in the same period of the prior year. Of these fees, approximately $5,951,000 wereWe recognized revenues from fixed price softwarevariable-fee license fees, and approximatelyrevenues of $4,088,000 an increase of $1,428,000, or 54% compared to $2,660,000 from variable price software license fees.in the same period of the prior year. The remainder of our revenues of $332,000 was from other items, such as the sale of equipment, supplies or accessories sales, which were $291,000 in the three months endedSeptember 30, 2019an increase of $41,000, or 14%, as compared to $53,000$291,000 in the same period of the prior year.and primarily represent licensing fees for software, which are usually billed as a fixed monthly feefixed-fee, or as a variable usage-based monthly fee.variable-fee dependent on usage. The primary reason for the increase in revenues was growth in the number of installed units from both new customers and established customers, which we believe is the result of our sales and marketing efforts.14$5,791,000$5,172,000 for the three months ended September 30, 2019, an increase2020, a decrease of $1,758,000,$619,000 or 44%11%, compared to $4,033,000$5,791,000 in the same period ofin the prior year. The primary reasonreasons for this change was increased compensationwere decreased personnel expense and lower travel expenses, as we modified our business practices in light of the sales team,COVID-19 pandemic. As a percentage of revenues, operating expenses decreased to 48% in the third quarter of 2020 as well as an increasecompared to 65% in our field sales, technical support personnel headcount and administration expenses to service our expanding number of customers.the prior year period. The changes in the various components of our operating expenses are described below.$974,000$820,000 for the three months ended September 30, 2019, an increase2020, a decrease of $359,000,$154,000, or 58%16%, compared to $615,000$974,000 in the same period of the prior year.The The primary reasonreasons for this change was increased costs due to increased sales volume of, placement ofwere decreased personnel expense and technical support for installations in the field. These increases were partially offset by lower depreciation per unit per month as a greater percentage of installations were software and sensor only rather than laptop, software and sensor, as well as lower residual value for retired units.partially offset by increased customer support expense. As a percentage of revenues, cost of revenues wasdecreased to 8% in the third quarter of 2020, as compared to 11% for both periods.in the prior year period.$617,000$672,000 for the three months ended September 30, 2019,2020, an increase of $30,000,$55,000, or 5%9%, compared to $587,000 in the same period of the prior year, as we continued work on ongoingproduct development and customization efforts.Sales and marketing expenseWe had sales and marketing expense of $2,345,000 for the three months ended September 30, 2019, an increase of $547,000, or 30%, compared to $1,798,000$617,000 in the same period of the prior year. The increase was primarily due to higher sales compensationincreased personnel and personnel expense, as well as increased headcount and expense, eachother costs associated with our product development and customization efforts, partially offset by lower consultant costs. As a growing business.percentage of revenues, engineering and product development expense was 6% in the third quarter of 2020, as compared to 7% in the prior year period.$1,855,000$1,564,000 for the three months ended September 30, 2019, an increase2020, a decrease of $822,000,$291,000, or 80%16%, compared to $1,033,000$1,855,000 in the same period of the prior year. The decrease was primarily due to lower personnel expense and lower professional fees. As a percentage of revenues, general and administrative expense decreased to 15% in the third quarter of 2020, as compared to 21% in the prior year period.growth in our business, which led to increased expenses to support a growing company, including higher infrastructure costs, insurance and other professional fees, as well as higher compensation and personnel expense.Other expenseWeforegoing reasons, we had other expensepre-tax net income of $3,000$5,595,000, for the three months ended September 30, 2019, a decrease2020, an increase of $75,000,$2,487,000, or 96%80%, compared to othera pre-tax net income of $3,108,000 for the same period of the prior year.$78,000$729,000 for the three months ended September 30, 2020, compared to income tax benefit of $4,671,000 in the same period of the prior year. The decreasetax expense in the current quarter was due to increased income from operations. The tax benefit in the prior year period was primarily due to the release of a decrease in interest expensetax valuation allowance.$73,000 associated with retirement of notes payable.Income tax benefitWe had an income tax benefit of $4,671,000$4,866,000, or $0.74 per basic share and $0.61 per diluted share, for the three months ended September 30, 2019, which included current tax expense2020, a decrease of $38,000 related$2,913,000, or 37%, compared to the period, offset by a $4,709,000 benefit relating to the release of the entire allowance against deferred tax assets. The remaining valuation allowance was released due to our recent history of eight straight quarters of positive income before income taxes, resulting in a credit to income tax expense. Due to full release of the valuation allowance, income in future periods may also result in tax expense.Net incomeFor the foregoing reasons, we had net income of $7,779,000, or $1.20 per basic share and $0.96 per diluted share, for the three months ended September 30, 2019, an increase of $6,311,000, or 430%, compared to a net income of $1,468,000, or $0.24 per basic share and $0.19 per diluted share, for the same period of the prior year. We had income before income taxes of $3,108,000 for the three months ended September 30, 2019, an increase of $1,640,000, or 112%, compared to income before income taxes of $1,468,000 for the same period of the prior year.1520192020 Compared to Nine Months Ended September 30, 20182019$23,616,000$26,530,000 for the nine months ended September 30, 2019,2020, an increase of $8,090,000,$2,914,000, or 52%12%, compared to $15,526,000$23,616,000 in the same period in 2018.2019. Our revenues are primarily from fees charged to customers for use of our vascular testing products and from salessale of accessories used with these products. We recognized revenues from fixed-fee licenses of $22,774,000 from fees for our vascular testing products for the nine months endedSeptember 30, 2019,approximately $18,718,000, an increase of $7,522,000$2,110,000, or 13%, compared to $15,252,000$16,608,000 in the same period of the prior year. Of these fees,We recognized revenues from variable-fee license of approximately $16,608,000 were from fixed price software license fees, and approximately$7,080,000, an increase of $914,000, or 15%, compared to $6,166,000 from variable price software license fees.in the same period of the prior year. The remainder of our revenues was from other items, such as the sale of equipment, supplies or accessories sales, which were $842,000 in the nine months endedSeptember 30, 2019$732,000, a decrease of $110,000, or 13%, as compared to $274,000$842,000 in the same period of the prior year.and primarily represent licensing fees for software, which are usually billed as a fixed monthly feefixed-fee, or as a variable usage-based monthly fee.variable-fee dependent on usage. The primary reason for the increase in revenues was growth in the number of installed units from both new customers and established customers, which we believe is the result of our sales and marketing efforts.efforts, partially offset by the decreased usage experienced in the first half of the year due to COVID-19.$15,956,000$16,564,000 for the nine months ended September 30, 2019,2020, an increase of $4,323,000,$608,000 or 37%4%, compared to $11,633,000$15,956,000 in the same period in the prior year. The primary reason for this change was higher personnel expense to support overall growth in our business which led to increased compensation of the sales team, as well as an increase in our field sales, technical support personnel headcount and administration expenses to service the expanding number of customers.customers, which offset the other decreases due to reduced travel in light of the COVID-19 pandemic. As a percentage of revenues, operating expenses decreased to 62% for the nine months ended September 30, 2020 as compared to 68% in the prior year period. The changes in the various components of our operating expenses are described below.$2,755,000$2,370,000 for the nine months ended September 30, 2019, an increase2020, a decrease of $756,000,$385,000, or 38%14%, compared to $1,999,000$2,755,000 in the same period of the prior year.The The primary reasonreasons for this change was increased costs due to increased sales volume of, placement ofwere decreased personnel expense and technical support for installations in the field. These increases were partially offset by lower depreciation per unit per month as a greater percentage of installations were software and sensor only rather than laptop, software and sensor, as well as lower residual value for retired units.partially offset by increased customer support expense. As a percentage of revenues, cost of revenues decreased to 12%,9% in the nine months ended September 30, 2020, as compared to 13%,12% in the prior year period, primarily due to revenuerevenues growing at a faster pace than cost of revenue.revenues.$1,777,000$2,277,000 for the nine months ended September 30, 2019,2020, an increase of $334,000,$500,000, or 23%28%, compared to $1,443,000$1,777,000 in the same period of the prior year.The increase was primarily due to consultant costs,increased personnel and other costs associated with ongoing projects related to our product development and customization efforts, including new applications for ourpartially offset by lower consultant costs. As a percentage of revenues, engineering and product development expense increased to 9% in the nine months ended September 30, 2020, as well as other product enhancements.compared to 8% in the prior year period.$6,626,000$7,283,000 for the nine months ended September 30, 2019,2020, an increase of $1,343,000,$657,000, or 25%10%, compared to $5,283,000$6,626,000 in the same period of the prior year. The increase was primarily due to higher sales compensation and personnel expense as well as increased headcount and expense, each associated with the continued expansion of existing customers, education, training, and associated expense, partially offset by lower travel expenses. As a growing business.percentage of revenues, sales and marketing expense decreased to 27% in the nine months ended September 30, 2020, as compared to 28% in the prior year period.$4,798,000$4,634,000 for the nine months ended September 30, 2019, an increase2020, a decrease of $1,890,000,$164,000, or 65%3%, compared to $2,908,000$4,798,000 in the same period of the prior year. The decrease was primarily due to lower professional fees, partially offset by increased expenses to support a growing company, including higher insurance and personnel expense. As a percentage of revenues, general and administrative expense decreased to 17% in the nine months ended September 30, 2020, as compared to 20% in the prior year period.growth in our business, which led to increased expenses to support a growing company, including higher infrastructure costs, insurance and other professional fees, as well as higher compensation and personnel expense.16Other expenseWeforegoing reasons, we had other expensepre-tax net income of $3,000$10,035,000, for the nine months ended September 30, 2019, a decrease2020, an increase of $264,000,$2,378,000, or 99%31%, compared to $267,000a pre-tax net income of $7,657,000 for the same period of the prior year.decreasechange was primarily due to increased income from operations in the present year period, as compared to release of a decreasetax valuation allowance in interest expensethe prior year period.$263,000 associated with retirement of notes payable.Income tax benefitWe had an income tax benefit of $4,594,000$8,614,000, or $1.31 per basic share and $1.07 per diluted share, for the nine months ended September 30, 2019, which included current tax expense2020, a decrease of $115,000 related$3,637,000, or 30%, compared to the year-to-date operations, offset by a $4,709,000 benefit relating to the release of the entire allowance against deferred tax assets. The remaining allowance was released due to our recent history of eight straight quarters of positive income before income taxes, resulting in a credit to income tax expense. Due to full release of the valuation allowance, income in future periods may also result in tax expense.Net incomeFor the foregoing reasons, we had net income of $12,251,000, or $1.91 per basic share and $1.51 per diluted share, for the nine months ended September 30, 2019, an increase of $8,625,000, or 238%, compared to a net income of $3,626,000, or $0.60 per basic share and $0.48 per diluted share, for the same period of the prior year.income before income taxescash of $7,657,000$16,793,000 at September 30, 2020 compared to $7,741,000 at December 31, 2019, and total current liabilities of $5,651,000 at September 30, 2020 compared to $5,207,000 at December 31, 2019. As of September 30, 2020, we had working capital of approximately $16,128,000.2019, an increase of $4,031,000, or 111%,2020 compared to income before income taxes of $3,626,000 for the same period of the prior year.Liquidity and Capital ResourcesWe had cash of $8,542,000 at September 30, 2019 compared to $3,284,000 at December 31, 2018, and total current liabilities of $4,747,000 at September 30, 2019 compared to $3,512,000 at December 31, 2018. As of September 30, 2019, we had working capital of approximately $7,340,000. Operating activitiesWe generated $9,093,000 of net cash from operating activitiesfor the nine months ended September 30, 2019compared to generating $2,651,000 of net cash in operating activities for the same period of the prior year. The improvementchange was primarily due to changes in net income, as well as both non-cash adjustments and changes in our operating assets and liabilities, which occurred due to growth in our businessbusiness. Non-cash adjustments to reconcile net income to net cash from operating activities were $2,047,000 and affectedwere primarily due to deferred tax expense of $1,224,000, depreciation accruedof $412,000, stock-based compensation expense of $190,000, loss on disposal of assets for lease of $178,000 and bad debt expense of $43,000. Changes in operating assets and liabilities used $1,061,000 of net cash, primarily due to prepaid expenses and other assets of $1,315,000, other non-current assets of $416,000, trade accounts receivable of $13,000 and accounts payable of $2,000, which were partially offset by cash provided by other current and non-current liabilities of $416,000, accrued expenses accounts payable,of $264,000 and deferred revenue and trade accounts receivable.of $5,000.used $453,000 ofgenerated $174,000 in net cash in investingfrom financing activities forduring the nine months ended September 30, 2018, which reflects purchases2020, due to proceeds from exercise of assets for leasestock options of $323,000 and fixed asset purchases of $131,000 to support our growing business.Financing activitiesofin net cash in financing activities during the nine months ended September 30, 2019, primarily due to the repurchasere-purchase of warrants of $2,687,000 from our chief executive officer in May 2019, partially offset by proceeds from the exercise of stock options of $60,000.20192020 and December 31, 2018,2019, we had no off-balance sheet arrangements.1720192020 and December 31, 2018,2019, other than employment/consulting agreements with key executive officers and our facilities lease obligation, we had no material commitments other than the liabilities reflected in our financial statements.management recognizeswe recognized that any controls and procedures,a control system, no matter how well designed and operated, can provide only reasonable, not absolute, assurance that the objectives of achieving the desired control objectives,system are met. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that all control issues and management isinstances of fraud, if any, within a company have been detected. Management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Our management,chief executive officer,management, including our senior vice president, financeChief Executive Officer, our Senior Vice President, Finance and accountingAccounting and our vice president, finance,Vice President, Finance, we evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act) as of September 30, 2020. Based upon that evaluation, our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance concluded that, because of the material weaknesses in our internal control over financial reporting, our disclosure controls and procedures were not effective. Notwithstanding the material weaknesses, our management, including our Chief Executive Officer, our Senior Vice President, Finance and Accounting and our Vice President, Finance, has concluded that the consolidated financial statements included in this Quarterly Report on Form 10-Q are fairly stated, in all material respects, in accordance with generally accepting accounting principles in the United States for each of the periods presented herein.endyear ended December 31, 2019:a. Insufficient segregation of duties, oversight of work performed and ineffective compensating controls in our finance and accounting functions due to limited personnel; b. Our information technology general controls related to user access security and change management controls related to our enterprise resource planning system were not designed effectively to provide an adequate audit trail for system change management controls and for the periodic review and testing of user access rights and permissions. c. We did not sufficiently design and effectively implement controls to validate the completeness and accuracy of underlying data used in the performance of various controls over accounting transactions and disclosures; d. We did not design sufficient protocols and procedures to retain adequate documentary evidence related to the timely review and approval of manual journal entries including the review of the underlying information at a sufficient level of detail; and e. We did not sufficiently design and retain adequate documentary evidence supporting the design and operating effectiveness of certain important management review controls including the precision of review and evidence of procedures performed. period covered by this quarterly reportmaterial weaknesses described above, combined with ineffective compensating financial close and review controls, had a pervasive impact on Form 10-Q. Basedour activity level cycles and accounts and creates a reasonable possibility that a material misstatement of the consolidated financial statements will not be prevented or detected on that evaluation,a timely basis. Although we have continued to implement our chief executive officer, our senior vice president, finance and accounting, and our vice president, financeremediation plan, these material weaknesses persist. Accordingly, management concluded that our disclosure controls and procedures were not effective at the reasonable assurance level, as of the end of the period covered by this report to ensure that information we are required to disclose in reports that we file or submit under the Securities Exchange Act of 1934 (1) is recorded, processed, summarized and reported within the time periods specified in Securities and Exchange Commission rules and forms, and (2) is accumulated and communicated to management, including our chief executive officer, senior vice president, finance and accounting, and our vice president, finance as appropriate to allow timely decisions regarding required disclosure, due to the existence of a material weakness in our internal control over financial reporting.September 30, 2020.ThereIn an effort to remediate our prior material weaknesses, in the third quarter of 2020, we continued to document our internal controls, including those adopted in prior quarters to address our material weaknesses, as we work towards our year end evaluation. Other than these remedial changes, there have been no changes in our internal control over financial reporting that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting during our third fiscal quarter ended September 30, 2019.2020.18Not applicable.None.Uponupon Senior Securities.None.Exh. No.19202019 2020 20